Stock market vs. statistics

Why the market rose despite indications of a U. S. recession,

The stock market is far from an ideal predictor of future prosperity, but in an imperfect world, it’s nevertheless one of the better ones. The past week provides a particularly dramatic example.

Some key economic measures published during the week suggested that the U.S. economy, the world’s largest, was faltering. If true, that would be a serious blow to countries like Canada that are heavily dependent on American sales.

Friday’s U.S. job report showed unemployment edging up to 7.9 per cent, while a leading gauge of consumer confidence dropped sharply. Most alarming, at least at first glance, U.S. economic growth actually fell into negative territory for the final quarter of 2012. That was a worse result than any of North America’s leading forecasters had foreseen and, at least potentially, a hint of renewed recession.

But interestingly, the stock market hardly hiccuped. Investors, at least, remained confident about continued economic growth.

Indeed, the market has soared. With Thursday marking the end of January trading, the broad-based S&P 500 Index of stock prices shot up by five per cent for the month. That’s the strongest January gain in 16 years. Based on history, this is at least a strong hint, if not a guarantee, that this year could see major gains in stock prices, suggests Robert Kavcic, an economist with BMO Capital Markets.

Of course, this assumes the market’s optimism is well placed. But a close look at the numbers suggests that the market did indeed get it right, while some high-profile economic statistics gave an imperfect picture of reality.

Still, the market is fallible, even if it’s right this time. It does a great job of digesting all the economic data, but it’s prone to overreacting. As Nobel Prize-winning economist Paul Samuelson once put it, “The stock market has predicted nine of the last five recessions.” This is partly because investors can be prone to irrational optimism or pessimism. Remember the tech boom?

Economic statistics don’t have this element of emotional excess, but they can mislead nevertheless. That’s because reality has too much complexity for any statistic to represent completely. To get the full picture, you have to delve deeper than the headline numbers.

For example, while U.S. unemployment edged up in Friday’s report, the number of jobs also rose. That’s possible for several reasons. A key one is that employment gains and losses come from one survey, while the unemployment rate comes from a second one. We know from experience that both surveys have frequent errors, sometimes big ones.

But if you step back and look at the trend over recent months, it’s clear that job growth in the U.S. is not only continuing, but accelerating. Some proof of this: Wage gains have hit a fouryear high, while full-time jobs are replacing many parttime ones.

As for the consumer confidence survey, many economists take these with a grain of salt. They do hint at future trends in consumer spending, but they’re subject to frequent changes, which can make it hard to know exactly what they’re predicting. And the rise in U.S. payroll taxes in January quite likely threw off the latest survey.

Maybe most important, that small fourth-quarter downturn in the U.S. economy is essentially meaningless; based on exceptionally big, and temporary, drops in two volatile factors. First was a plunge in government defence spending, which was somewhat predictable after an unusual jump in this category in the previous quarter. Second was a sharp drop in inventory accumulation by industry