It's Not the Economy, Stupid!
Over the past 48 hours, global markets have lived a life cycle, from panic and fear through uncertainty and confusion, and then, finally, euphoria. The individuals and machines placing the trades have been along for the ride, and if you stepped away for lunch or coffee, you risked exiting the movie at a crucial plot point, asking distracted friends and colleagues, “What just happened?”
What happened was a flash crash followed by a flash rally. It’s too soon to tell if the carnage in the markets are over, though it is telling that the reaction to President Obama speaking in homilies on Monday was a rash of selling, while the reaction to Ben Bernanke and the Fed announcing another year and a half of astonishingly low interest rates was a rash of buying. Obama said nothing that would satisfy the desire of market makers for clarity, promising only committees, process, and indomitable spirit. Bernanke and the Fed, though not unanimous in their assessment, offered a clear future of cheap capital and low rates. That at least was something on which to hang hats, and so investors did.
The sell-off that began last week brought out a host of commentators who jumped on the bad news of the markets and used that to tell grim stories of a global economy on the brink. Sell-offs produce bad news the way sinking ships produce rats; on days of vertiginous decline, the odds of hearing someone preach the gospel of growth and prosperity are decidedly slim.
It was no surprise to see Nouriel Roubini burnishing his brand as Dr. Doom on Monday, warning not just of a recession in the United States and a near-collapse of the Eurozone, but also a sharp slowing of global manufacturing stretching from China through India, Brazil, and Germany. One analyst on CNBC, cheering on the rise in gold prices, predicted that the financial system would soon become so perilous that the president of the United States would be forced to confiscate European gold holdings stored in the vaults of New York in order to maintain American economic viability once cash currencies collapsed completely.
Even facts were subject to the optic of impending collapse. China released a raft of economic data late Monday night, showing inflation at an expected 6.5%, industrial production up 14%, and retail sales up 17%. That sounds like an economy charging ahead – and in a fast-growing economy, you want healthy inflation (not too much, but God forbid too little) to augment domestic spending. But one Goldman Sachs analyst out of Asia captured Wall Street sentiment perfectly when he described the data as proving that China was “weakening.” Why? Because industrial production was expected to reach 14.9% and retail sales were shy of the predicted 17.7%.
Only in the midst of a sell-off tinged by group-think could these numbers be made to be bad. Yes, China is likely slowing relative to periods of even more torrid expansion over the past five years, but so what? It is still consuming global commodities with a nearly insatiable appetite and in turn focusing on domestic markets and innovation (including a move toward renewable and alternative energy parallel to its voracious consumption of carbon). The sell-off in equities and China’s own discontent with its dependency on the U.S. dollar did nothing to alter any of that.
And as for the looming U.S. recession that generated a bandwagon of consensus so full it’s a wonder it didn’t tip over, Disney reported results that showed its theme parks did 12% more business, and ad sales were up healthily in its entertainment divisions. That matched reports of other media companies that saw better ad revenue over the past months. Ad revenue and theme parks don’t see those trends unless domestic consumers are spending money; companies don’t increase advertising budgets on slumping sales, and theme parks don’t fill with bodies if people can’t spend.
The reality has been and remains that part of the United States is mired in recession, depression, or whatever word you wish to use for a protracted period of stagnation, unemployment, declining wages and waning spending power. A numerically smaller portion is thriving, and a very small portion is really thriving. Whether the “economy” grows 2.5% or 0% for the next year won’t change that reality, and all the recent analysis about whether we enter a recession misses the point that the recession never ended for tens of millions and hardly ever existed for millions more.
The idea that the recent sell-off validated the grim news in the economy should have the corollary that Tuesday’s massive surge validated a rosy view of just how stable everything is and how much we are thriving. Both conclusions would be wrong, because market moves such as these do not validate any directional view of overall economic conditions. Over time, financial markets do reflect underlying real-world economic fundamentals, but not at moments of massive capital flows in and out of stocks and bonds trading trillions of dollars, executed in milliseconds.
The need for daily stories, however, means that these moves beget discussions of what is going on economically in the world, and inevitably, markets going down generate discussions of economies heading south while markets going up produce commentary about economic boom times. Neither is right. And the consequences of making such false correlations are not just bad investing decisions. No, creating a strong link where only a weak bond exists might satisfy some need for coherent stories but it does no good helping us navigate either financial markets or real world economies.
Markets fall; economies fail; markets soar; economies thrive. Sometimes they are linked, and often they are not. Forcing a link won’t make you money in the markets, and it won’t help us solve pressing issues of where our economies are failing the needs of citizens. Obama should have made that clear; pundits should have made that clear; that they did not is almost as unsettling as the whipsaw in the markets this past week.