Financial Gain, Economic Pain

In the past three months, global asset prices have rebounded sharply, reflecting investors' growing expectations of economic recovery. But, despite an improvement in economic fundamentals, the role of less sustainable factors is equally clear, while the sharp rise in some asset prices threatens the recovery of a global economy that has yet to hit bottom.

NEW YORK – In the past three months, global asset prices have rebounded sharply: stock prices have increased by more than 30% in advanced economies, and by much more in most emerging markets. Prices of commodities – oil, energy, and minerals – have soared; corporate credit spreads (the difference between the yield of corporate and government bonds) have narrowed dramatically, as government-bond yields have increased sharply; volatility (the “fear gauge”) has fallen; and the dollar has weakened, as demand for safe dollar assets has abated.

But is the recovery of asset prices driven by economic fundamentals? Is it sustainable? Is the recovery in stock prices another bear-market rally or the beginning of a bullish trend?

While economic data suggests that improvement in fundamentals has occurred - the risk of a near depression has been reduced; the prospects of the global recession bottoming out by year end are increasing; and risk sentiment is improving - it is equally clear that other, less sustainable factors are also playing a role. Moreover, the sharp rise in some asset prices threatens the recovery of a global economy that has not yet hit bottom. Indeed, many risks of a downward market correction remain.

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