The U.S. economy has just suffered its first contraction since 2009, consumer confidence has plunged since November’s election and Americans’ paychecks are only just starting to reflect an increase in payroll taxes averaging $70 per month. Across the Atlantic, the euro zone and Britain seem to be sinking back into recession. And conditions in Japan have become so desperate that newly elected prime minister Shinzo Abe is openly devaluing the currency and threatening to take direct control of the central bank.
At the same time, stock markets around the world are approaching or exceeding records. Money is flowing into equity mutual funds at the fastest rate since the end of the last bull market in 2000. And business sentiment, as reported from Davos, seems to be more optimistic than at any time since the global financial crisis of 2008.
Is there a rational way to explain these contradictions? Will the business and market optimism be sustainable? Or is this sudden euphoria just another financial bubble, sure to be punctured if the grim message from recent economic indicators sinks in? The likely answer to all these questions is yes.
Let us begin with the last question, on recent economic figures. If these grim statistics – especially Wednesday’s unexpected report of a 0.1 percent decline in U.S. gross domestic product in the fourth quarter – give an accurate picture of global economic conditions, then financial markets and optimistic business leaders are headed for a fall. The markets and executives, however, are betting they understand conditions better than the statisticians, or, to be more precise, that the weakness implied by the figures is an aberration that lays the foundation for a strong economic rebound in the months ahead.
Regarding the much-worse-than-expected U.S. GDP statistics, this contrarian view is almost certainly right. The figures were severely distorted not only by superstorm Sandy but also by huge cutbacks in government spending, especially on defense equipment, that were probably related to November’s election and precautionary moves ahead of the yearend “fiscal cliff.”