Stockmarkets & Economies Divide

The UK economy has been sick as a dog for well over a year now and remains in recession. So why has the UK stockmarket been performing pretty well this year?. Aren’t stockmarkets supposed to be a good indicator of a country’s economic health?

The possible reasons for this are many, but let’s look at the most likely, starting with the obvious. Fears of a global financial meltdown during 2008 hit stockmarkets incredibly hard, so when the banking system didn’t collapse investors breathed a huge sigh of relief and markets (especially bank shares) rose as a result, despite many global economies still being in deep water.

In the UK this has been exacerbated by the dominance of the financial sector on the stockmarket. Financial companies make up about a quarter of the FTSE 100 Index, so they have a big influence on overall performance.

Aside from financials, the other big UK stockmarket sector is oil & gas. Performance of these shares has very little to do with the UK economy and a lot to do with global demand for energy, especially from emerging markets such as China.

So we can’t ignore the fact that Britain is not an island when it comes to stockmarkets. Many companies listed on the London Stock Exchange trade globally, meaning their fortunes depend on economies overseas and not just the UK - only around a third of UK stockmarket revenues come from Britain. The weak Pound (a symptom of our depressed economy) has also helped boost these overseas revenues, as they’re worth more when converted back to Sterling – good news for some share prices.

Companies in areas that rely heavily on UK customers, such as construction, leisure and retail have found the going harder and these sectors continue to lag most of their stockmarket peers.

Finally, let’s consider expectations. If stockmarkets are efficient then they should reflect where investors think the future is headed. They’ll buy shares (pushing up prices) when they think prospects are rosy and sell when they think the future is grim. Does a rising stockmarket this year mean investors think the economy will be taking a turn for the better sometime soon? Is there simply a lag between the two? History suggests this might be the case, but also that investors are quite often wrong too!

My own view, for what it’s worth, is that this time they’ve got it wrong. I think the UK economy will remain troubled for at least another year or two yet and the stockmarket will struggle too, despite some possible respite for the reasons covered above.

In summary, while stockmarkets do appear to generally reflect economic health over periods of several years, it’s less likely short term, especially in the UK.

View this and other comments at www.candidmoney.com