The Week: The global economy is teetering: why are markets ok about it?

Markets rallied in July in spite of some tough economic data. They are hoping weaker growth may force a change of heart from the Federal Reserve.


  • The US has now slipped into a technical recession, while inflation continues to defy expectations
  • The Federal Reserve and Bank of England have announced significant rate rises
  • The strength of markets in July is likely to prove a false dawn

The economic picture is darkening. The US has now slipped into a technical recession, while the Bank of England is now predicting a lengthy recession, starting in the fourth quarter of this year. Inflation continues to defy expectations, reaching ever-higher peaks, while consumer confidence has fallen off a cliff. Yet the stock market has been relatively resilient. What explains this apparent optimism in the face of some grim economic statistics?

Few now doubt that the economic picture is going to get worse. In the longer-term, there are solutions – higher interest rates should act to curb inflation, other energy sources will come on stream, relatively buoyant jobs growth may allow households to survive in spite of price rises. However, no-one is predicting anything good to happen in the short-term.

Yet markets have shrugged off this gloom. The S&P 500 is up almost 8% since the start of July, along with the majority of global markets. Many of the hardest hit areas – China, technology, higher growth sectors – have staged a recovery in recent weeks. 

In doing so, investors are putting an optimistic spin on recent statements from the Federal Reserve. The central bank has said it will offer less guidance on the direction of rates in future and will be led by economic data. Investors believe that weakening data will slow the pace of rate rises and this has changed their view on certain interest-rate sensitive sectors. 

However, it is difficult to see this as a sustainable rally. The stock market needs to contend with an inevitable decline in earnings over the next few months, plus a barrage of worsening economic data. It also needs to accommodate quantitative tightening (‘QT’), where central banks start to shrink their balance. The role of quantitative easing in boosting asset prices is well-understood – will it exert similar downward pressure when it is reversed? 

Investment trust Ruffer said in its recent results statement: “This bear market is not over, and we believe that we are entering its most dangerous phase. Liquidity is being drained from the financial system.” It is perhaps at the gloomier end of multi-asset managers, but it is easy to agree with the view of its managers. 

The strength of markets in July is likely to prove a false dawn. The consoling factor for investors is that prices have already fallen a long way and are still discounting a fair degree of bad news. Whether it will match the actual bad news though is still open to question.