How to Read the Week’s Economic and Market Signals

The last few days served as a reminder of the inconsistency between the economy and markets. Next week will provide insights on what, until now, has been the great reconciler – namely, the hyperactive experimental policies of central banks

Friday’s disappointing GDP growth – 2.5% in the first quarter, short of the consensus forecast of 3% -- was the latest signal that the U.S. economy has again hit an air pocket. It followed disconcerting data on manufacturing and durable goods. Indeed, Thursday’s jobless claim number was the only major indicator to surprise on the upside.

While worrisome, this pales in comparison to what last week’s data told us about Europe. Economic weakness now encompasses both “core” (think Germany) and “peripheral” economies. In the case of the latter, unemployment is rising from one awful record to another. (In Spain, for example, the rate increased to 27.2%, with an even more stunning 57.2% rate among the young).

Last week’s corporate earnings suggest that companies are still able to counter a worrisome revenue situation by cutting costs.

This option is not open to households. The average saving rate has already declined to quite low level; and it conceals the fact that better-off households continue to gain while others face even greater pressures. Ultimately, it is households – here and abroad – that provide demand for what companies make and sell.

In light of this, expect next week’s policy meetings to signal that central bank stand ready to step in, once again, to maintain the disconnect between buoyant equity markets and sluggish economic conditions – not as an end in itself but, given Congressional dysfunction, as virtually the only way today to support economic activity (and it is rather imperfect as the expected benefits come with growing costs and risks).

Look for the Federal Reserve to alter the thrust of its policy narrative. Rather than advance its prior emphasis on tapering its monthly $85 billion purchases of market securities, it will seek to reassure markets by iterating its willingness to do more if needed.

Across the Atlantic, the European Central Bank will face increasing pressure to cut its interest rate (currently at 0.75%) and liberalize the collateral requirements it imposes – both meant to loosen monetary conditions.

Such policies, combined with the very aggressive monetary measures of the Bank of Japan, provide comfort to investors. Sadly, the beneficial effects do not extend to the economy in a material fashion. Here, unfortunately, outcomes fall short of both expectations and what is urgently needed.

Given the underpinnings of both hyperactive central banks and our persistently sluggish economy, don’t look for the unusual disconnect to disappear overnight. But don’t be fooled into believing it can last forever.

At some stage, convergence will occur. Either artificially high valuations will be validated by improving fundamentals; or they will fall to levels warranted by weak fundamentals.

Neither possibility overwhelmingly dominates the other at this stage. Moreover, timing remains uncertain. Much depends on what happens in the coming weeks and months.

Such a wishy-washy conclusion is far from satisfactory. Yet today it is the inevitable outcome of this period of enormous fluidity in the global economy and politics.

Whether you are a worker or an investor, a student or an entrepreneur, this is the time for a combination of resilience and agility.

Monitor developments carefully. Maintain as much operational optionality as possible. Be opportunistic. Understand your downside. And do not lose sight of the artificiality of current economic and market conditions.

It is best to recognize today’s “unusual uncertain outlook” (using Fed Chairman Ben Bernanke’s characterization) rather than predict confidently (and foolishly) on the basis of partial information and incomplete analysis.

Photo: JMR_Photography/Flickr, used under a Creative Commons license.

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