Why stock markets boom despite economic weakness

THE disconnect between stock markets and their respective economies continues to play out in earnest, as global indices have hit new multi-year (if not all-time) highs. In theory, equity markets and economic performance are interlinked, so it’s no wonder that so many people are asking the same question over and over again: why are stock markets bounding higher while economies are flatlining at best?

Many developed economies around the globe, in particular in Europe, are finding the going particularly tough. Even Germany, Europe’s economic powerhouse, is under the cosh, as recent data from the country has shown. Although official figures yesterday showed industrial orders rose 2.2 per cent compared with the previous month, Markit’s Purchasing Managers’ Index suggested factory activity fell in April for the second month, and at a faster pace than in March.

The whole Eurozone remains embroiled in a debt crisis that is causing unemployment to remain stubbornly high. But while companies are not taking on new staff, they are still managing to keep fixed costs low, and are therefore in a strong financial position. This means that much of the spare cash that is lying around is being returned to investors in the form of share buy-backs and dividends. Such an environment makes equities attractive to investors seeking not only income, but return on capital. These conditions are being provided by firms that are in control of their fixed cost base and benefiting from a global economy that is still expanding at a decent pace.

The other condition keeping investors’ appetite for risk intact is the near cast-iron guarantee that central banks are almost certain to intervene if the economic situation takes a turn for the worse. Despite losing count of the times they have tried to talk down their role in directly supporting their respective economies by trying to put the ball in the court of the politicians, it’s the politicians who ultimately have the power to lean them towards their way of thinking. In other words, politicians are saying to central bankers: you can keep your jobs if you improve the economy so I can get re-elected.

Monetary easing seems to have become a drug that is going to be almost impossible to wean off. It’s very much in vogue for central banks at the moment and, with interest rates close to or at zero, central banks will have to become even more creative with their unconventional policies in order to keep their programmes going. There is, of course, the possibility of zero interest rates on deposits as well, which has also been put on the table recently.

With so much liquidity sloshing around, the situation for many corporations around the world remains stable at worse, and an environment to seek opportunities at best. So despite the economic outlook remaining a real challenge, for equity markets it looks like the trend remains the bull’s friend.

Angus Campbell is head of market analysis at Capital Spreads. You can follow him on Twitter @angusjmcampbell

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