Financial markets are racing well ahead of the real world

Financial markets are racing well ahead of the real world


Positive thinking is a powerful force, even when it doesn’t make much sense. That is one explanation for the mounting exuberance in financial markets.

By Edward Hadas, breakingviews.com

Last Updated: 8:50AM BST 06 May 2009

It’s not exactly 1996, when Alan Greenspan, the then chairman of the US Federal Reserve, warned of “irrational exuberance”. But there is an uncanny similarity in investors' willingness to look on the bright side.


Not all of today’s exuberance is irrational. The narrowing of credit spreads, to levels before the collapse of Lehman Brothers, can be linked to effectively unlimited government support. The reversal of stock market losses in the first few months of 2009 may be a justifiable response to green shoots of economic recovery – even if economists, corporate bosses and politicians are doubtful of the turn.

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But overall, markets and indicators are diverging. The price of oil has risen from $40 to $53 a barrel since February, but inventories are up and demand is down. US bank shares have risen sharply in spite of leaks that 10 out of 19 of them would fail the government’s not terribly exigent stress tests. Meanwhile, government bond yields are barely moved by deficits that would have been considered tragic a few years ago.


Bulls argue that the markets are thinking ahead: oil demand will turn soon and banks will shortly generate decent earnings to offset their losses. As for the deficits, the government can always shut down the money presses before inflation takes hold.


These may be true, but they do not justify the market euphoria. They are reminiscent of the dubious explanations provided by suspects in murder mysteries. Readers are well advised to ignore them, and look for the love interest. In market mysteries, the answer can be found in the money.


In the 1990s, too much money flowed into markets, thanks in large part to Greenspan’s low official interest rates. Now generous central banks and profligate governments are trying to keep the economy afloat with vast amounts of funding. Investors get first dibs on much of the cash. That kick starts markets. And that can help the economy. But right now, the markets are well ahead of the real world.


For more agenda-setting financial insight, visit www.breakingviews.com



http://www.telegraph.co.uk/finance/breakingviewscom/5278103/Financial-markets-are-racing-well-ahead-of-the-real-world.html