Stock markets and economies are not intertwined

The gut-wrenching moves in equities in recent days raise a number of questions.

For one, are the declines indicative of an underlying problem in the global economy? And two, do the losses threaten to spark some sort of contagion?

It’s still early days, but the answers lean toward a strong “no”. What is notable about the sell-off, in which the MSCI All-Country World Index has dropped as much as 10.7 per cent from its highs last month, is that there hasn’t been a mass grab for havens. Yes, US Treasuries were in demand on Monday, but that reversed somewhat on Tuesday. And other assets favoured in times of turmoil have barely budged.

At about $1,335 an ounce, gold is actually down from its January highs of $1,358. In the currency markets, a Bloomberg index of the yen against the dollar, euro, pound and six other major peers is hovering around its lowest since early 2016. Measures of stresses in the banking system such as the Libor-OIS spread are little changed over the past month, suggesting no one is worried about banks getting in trouble.

The tumble in stocks is being attributed to a range of causes, including the unwinding of what could be almost $2 trillion in bets tied to low volatility, signs of faster inflation, hawkish central banks and higher bond yields. That may all be true, but it’s just an excuse for investors to take a bit off the table at a time when there’s been concern about high valuations and complacency. Remember: the S&P 500 Index had gone a record 404 days without a 5 per cent drawdown.

Just two weeks ago, the

IMF raised its forecast for global economic growth this year to 3.9 per cent, up 0.2 percentage point from its projection in October. That would be the fastest rate since 2011, when the world was bouncing back from the financial crisis. Despite a minor pullback last month, global economic data are beating forecasts by a healthy margin and at a pace that corresponds with stronger growth. Foreign-exchange reserves for the 12 largest emerging-market economies, excluding China, have risen to $3.17tn from less than $2tn during the financial crisis, providing an ample cushion if times get tough, according to Bloomberg data.

Corporate earnings are hopping. Through February 2, 251 of the S&P 500 companies had reported results for the fourth quarter and 77 per cent beat expectations, according to Bianco Research. Should this level hold, it will be the highest of the post-crisis period. There’s more: year-over-year operating earnings growth now exceeds 15 per cent and analysts have increased their forecasts for full-year 2018 earnings to 20 per cent, according to Bianco. The company notes that even though the S&P 500 was up 26 per cent between Janury 1, 2017, and February 2, 2018, stocks are the cheapest they have been in a year based on price-toearnings ratio using 12-month forward earnings estimates.

The markets went through something similar two years ago, when concerns about a slowdown in China’s economy and high debt levels there sent the MSCI All-Country World Index down 1.93 per cent in December 2015 and 6.09 per cent in January 2016. Although US GDP came in at a sluggish 0.6 per cent in the first quarter of 2016, it soon rebounded to above 2 per cent growth for the next two quarters.

As Evan Brown, director of asset allocation on the investment solutions team at UBS Asset Management, said this month: “The underlying strength of the economy is still healthy. The overall level of interest rates is still quite low. If anything, we’re surprised that it took so long for us to get a 3, 5 per cent correction in the market.”

Bull markets end when economies go into recession, not because of high valuations. There is nothing on the horizon to suggest the economy is on anything but stable ground. Violent fluctuations, however painful, happen, but history shows that the fundamentals ultimately prevail.

Global economic data are beating forecasts by a healthy margin and at a pace that corresponds with stronger growth