Last Updated: Sat Dec 25, 2010 10:51 am (KSA) 07:51 am (GMT)

A merry Christmas but not necessarily a happy new year

Asa Fitch

European markets may be toasting their best December in a decade but, at the risk of sounding Scrooge-like, I wouldn't put too much stock in the Christmas season rally.

 Fundamentally, we know very little about what next year will bring, given the nature of this prolonged period of global stagnation 

The numbers, to be sure, are worthy of celebration. The UK's FTSE index yesterday closed above 6,000, a level some market-watchers call "psychologically important". Stocks in the US have had similarly festive gains this year, with the S&P 500 index up 11.6 per cent and the Dow Jones Industrial Index up 9.7 per cent.

Those gains could be an augury of even happier returns next year. At the same time, however, we should be careful not to link the rise in stock prices to the imminent end of Europe's or America's economic woes, which is really what we're hoping next year brings.

The problem with looking at markets for signs of recovery is that stocks are incredibly easy to trade. Anyone can go to a broker and buy or sell stocks, sending their prices up or down.

That ease of exchange means stock prices reflect two things: investors' views on the current state of things and, more importantly, their current take on the future. Investors make money by buying at low prices and selling at higher ones. Investors who buy, thus sending prices up, are essentially predicting that investors view the future as better than today.

That may seem like a good sign that economic fortunes will improve next year. Investors, after all, are betting that they will. Reinforcing that view, previous experience has shown that markets tend to rise in advance of economic recovery - though not always.

There is one important caveat: if we've learned anything from the global economic crash, it is that surprising changes in the world economy are not out of the question. Last year was also a bullish one for global markets but it's safe to say that few investors were factoring in the likelihood of a sovereign debt crisis in Europe or the so-called currency war raging between the US and China.

There is still a lot of uncertainty about a full emergence from the global downturn, and to see rises in markets as evidence that economic problems are going to be sorted out successfully next year would at the least be optimistic. Stock prices are a symptom of the mood among investors, not an incontrovertible proof of a coming boom.

Indeed, against the backdrop of a euro zone in crisis and further bailouts likely to be on the way amid sovereign credit rating downgrades for several countries, it would seem absurd to take a bumper December for the continent's stocks as some sort of infallible signal that next year will be a good year.

The real test of whether we can peg this season's market swing as the beginning of a recovery will only come later, when lagging indicators start to catch up with leading ones. What we want to see next year is higher economic output as businesses start to increase production because they, too, see better times ahead. We want to see reinvigorated lending by banks to help finance growth and production. And of course we want to see double-digit unemployment recede in the developed world.

Those are the things that matter to participants in the economy, and we should see the recent rise in global markets in that context. Fundamentally, we know very little about what next year will bring, given the nature of this prolonged period of global stagnation. There's no telling how the global economy will surprise us, let alone how the markets will react to it.

Uncertainty, however, shouldn't prevent us from being hopeful. The IMF is forecasting 2.6 per cent growth in the US next year and 2 per cent for the UK, with more robust performance for emerging economies such as China and India. The UAE is slated to do pretty well, too, with 3.2 per cent growth forecast.

Recent polls of economists are also showing decent unemployment forecasts for the developed world. The rate for the US is expected to be about 9 per cent next year before falling further in 2012. The European Commission said in a report last month that it is expecting 10 per cent unemployment for the euro zone next year, a slight dip from this year.

It's those things - economic growth and unemployment - that we need to focus on when we talk about prospects for next year. Most of us, after all, would probably rather see economies growing and unemployment shrinking while stock prices stagnate than a rally in markets coupled with slow growth and job losses.

European markets' best December in a decade is nothing to grouse about. But only time will tell if it is the beginning of a real turnaround and not a temporary upturn caused by fickle investor sentiment.

*Published in the UAE-based THE NATIONAL on Dec. 25, 2010

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