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Are we out of the woods?

April 22, 2009 20:24 IST

Strangely, over the past few weeks, stock market behaviour and macroeconomic data have not moved in sync with each other.

In fact, it would be fair to say that they have actually moved in the opposite directions. While macroeconomic data has shown little or no signs of inspiration, stock markets around the globe, especially in the emerging markets, have behaved as if there is no global recession happening.

Even well known fund managers like Mark Mobius have come out and proclaimed that the current rally could well be the start of a new bull market.

Hence, the question is how one reconciles the two, i.e., the stock market rally and macroeconomic data.

In a recent report, released by the IMF and analysed in good detail by one of India's leading business dailies, an attempt has been made to arrive at a proper reason behind the disconnect.

As far as recovery on the macroeconomic front is concerned, the report tries to compare the current recession with the previous recessions and argues that even if we consider the average time taken to plunge into the trough and rise back to the previous peak, we are still a fair distance away from a recovery.

In fact, we have not even taken into account the fact that the current recession is far worse than the previous recessions and hence, the time taken could be even longer.

Now, let us talk about the positives. The report has compared the current slowdown to the Great Depression and has mentioned that although there are quite a few similarities like fall in asset prices, drastic slowdown in lending and deflationary threats, steps taken in the aftermath of the crisis have been way better than the Great Depression.

While many governments had erected trade barriers back then and the world was still on the Gold Standard, a coordinated policy action this time around and the ability of central banks to print money are the key differences that will go a long way in ensuring that the current crisis may well not turn into another Great Depression.

In fact, this is something that a lot of economists and investors have come to agree. The solution to the question of a strong equity market rally in recent times could also be deciphered from these key differences.

First, investors were already pricing in the Great Depression when the troubles first started erupting and hence, when the reality dawned upon them, some pullback was naturally expected.

Second, the money supply has also expanded dramatically thus making enough liquidity available in the system, some of which is finding its way into the stock markets.

Hence, to conclude, a combination of factors like unwanted pessimism and greater availability of money is the driving force behind the current stock market rally. Will the markets once again touch the lows of last year? Unlikely. Will they rise even higher? Well, only time will tell.

Equitymaster.com