One thing we should have learned in 2008 is that the stock market is NOT driven by rational estimates of future performance in the real economy, but rather — as George Soros and George Akerlof have argued — by animal spirits (e.g. group optimism or pessimism).
Optimism is back in style. Perhaps in part because profits on Wall Street are back to 2008 levels, traders on Wall Street are driving stocks upwards toward their previous highs (retail investors are still on the sidelines, their money in cash or bonds).
So what justifies the optimism that brought stocks back nearly to pre-bust peak levels, with the Nasdaq over 3000, the S&P 500 over 1400, and the Dow over 13,000?
In a word — nothing. Let us look at current growth figures for the world’s ten largest economies, examining the last two quarters (2011 IV and 2012 I). The figures below present the growth in GDP during those quarters, at annual rates:
BRAZIL: -0.4%, 1.2% CHINA 9.2%, 8%
INDIA: 6.9%, 6.1% GERMANY: 2.4%, -0.8%
FRANCE: 1.2%, 0.8% UK: 2.0%, -0.8%
US: 1.8%, 3% ITALY: -0.8%, -2.8%
JAPAN: 7% , -0.8% CANADA: 2.6%, 2.2%
Brazil’s growth ticked up slightly but remains anemic; every other major economy except the U.S. slipped markedly from the last quarter of 2011 to the first quarter of 2012 — in Germany, the UK, Italy, and Japan growth was negative. China’s growth decline was particularly marked, and their government is projecting a further fall in growth to 7.5% in for 2012 as a whole. European nations are stuck in Germany’s demanded austerity policies. And oh yes, oil prices have shot up and will remain high as long as uncertainty over an attack on Iran’s nuclear facilities persists, which seems likely to continue throughout the year. In short, globally, it looks like the burst of growth we saw in the fourth quarter of 2011 is giving way to a renewed slowdown, that will likely be exacerbated by higher fuel costs.
Another thing we have learned in the last few years is that the days in which one or two major countries could pull the world economy along or make up for declines elswhere are also gone. The global economy is now so interconnected that the major economies all grow or slump together; divergence cannot be sustained for very long.
So was the 3% annual growth in the US in the first quarter just a fortunate result of the warmest winter in many years, and a burst of post-holiday splurging of pent-up demand on big-ticket items? Housing prices are still falling in most markets, and deleveraging still has a long way to go. US wages are still nearly flat except for the top 1% of income earners. In January 2012, wages were up only 1.5% over last year, while prices were up 2.3%. If wages continue to grow less than inflation, it is hard to see how growth in the overall economy can continue at 3% rates.
Optimism about the US economy has to assume that (1) US growth is underway and will continue to pick up despite flat wages and rising oil prices; and (2) US growth will push global growth rates up, rather than US growth being dragged down by growth declining elsewhere all around the world.
Will the optimists be proved right in the rest of 2012? Who knows — the nature of bubbles is they grow on optimism beyond any rational reason, then collapse without warning. But unless growth returns in other countries, the current expectations for a strong US recovery look more like a bubble than a true economic boom.