Are markets saying the bust is over?

The recent strong rises in equity markets suggest that a recovery may be on the cards. Now we need some hard economic data to confirm our hopes.

Are all the economic pessimists wrong?

Financial market movements over the past few months suggest the world economy is poised for a recovery, even if in the hard economic data there are few signs of it.

While the northern hemisphere summer is usually sleepy time for financial markets, in the last few months there have been some quite remarkable market trends. If these trends are sustained, it would suggest the dog days are over for the world economy.

It is clearly too early to suggest that the likes of the US, the eurozone or the UK are set for a strong economic pick up. The banking, sovereign debt and unemployment problems are still deep. China is slowing with growth at a three year low and there is speculation that there will be further policy easing from the PBoC to arrest the disinflation pressures unfolding.

The recent rise in share prices, bond yields and commodity prices are all consistent with better economic times ahead.

Here are some facts. From a recent low in early June, the US S&P 500 index has risen a tidy 11 per cent, with a similarly impressive gain recorded by the FSTE in the UK.

In Europe, share prices have registered substantial gains – in France the CAC is up 18 per cent, which coincidently is the same rise recorded by the German DAX. Even the beleaguered Nikkei in Japan is up 10 per cent since early June, which happens to be the same increase that the ASX has recorded from its June low.

Share prices are usually a great barometer of the future health of the economy. Poor economic growth prospects will inevitably coincide with the corporate world struggling to make and build profits, which is why, very simply, share prices fall in a recession. The opposite is also true. In a strong economy, companies make profits and even the less vibrant ones can do well, which in turn validates rising share prices.

All of which makes the recent double-digit increases in share prices all the more interesting.

The favourable market signals don’t stop there. Over the past month, there has been a sell off in government bonds yields. Ten-year yields in the US are more than 40 basis points higher over that time; in Germany, yields are 30 basis points higher; in Australia, the rise is 65 basis points.

While these increases in bond yields are coming from record lows, the sell-off, so far, is hinting that the super safe haven of government bond markets is starting to be reassessed. Government bonds are not a good investment in a climate of accelerating economic growth and higher inflation. It would be wrong to overstate the signals coming from the bond market in the past months as yields are still stunningly low (1.8 per cent in the US, 1.6 per cent in Germany and 3.5 per cent in Australia for example), but there just might be something there for the optimists.

The next market move of note is for commodity prices. The broadly based Thomson Reuters/Jefferies CRB index of commodity prices has risen more than 13 per cent (in US dollar terms) in the last two months. This move partly reflects higher grain prices as the US drought has decimated farm output, but also it may be a straw in the wind suggesting a turn in economic activity.

While commodity prices clearly have both a supply and demand aspect to them (note the price rises for corn due to the US drought), the rise in the price in some industrial commodities fits with the other market news of rising stock markets and higher bond yields.

These market trends may yet prove to be a false signal of better times ahead. They may just as quickly turn down as they have risen and certainly the key economic news around the world remains grim.

But the fact that there has been a significant and coordinated rise in stocks markets, bond yields and commodity prices has got to be seen as good news for those wishing the global economy to grow. If sustained, we could be witnessing the green shoots of better times ahead for the global economy.

The hard economic data needs to surprise on the upside in the next month or two to validate these market moves.

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