The interesting theme that emerged from last week's market mayhem is how the story driving market movements has suddenly shifted from banking problems to the overall economy. Until last week, every market move was traced back to banks or investment banks in trouble and the governments' attempts to bail them out. Last week, the collapse of the markets was almost entirely attributed to the recession that investors/economists see looming for next year.
While I am not dismissing the notion, it is worth looking at history to see how good or bad a predictor the market is, when it comes to the real economy. Someone far wiser than I once said that the market has predicted ten of the last seven recessions. I think that saying captures both the strength and the weakness of the market. Most economic slowdowns have been preceded by market declines but not every market decline has been followed by a slowdown. A drop of the magnitude that we are witnessing is signaling that economies will slow down, but we should be not so quick to jump to the conclusion about how steep that decline is going to be.
Note that embedded in every market slowdown are also the ingredients for the recovery of the economy in the future. While we should be worried about how quickly banks can return to what their real mission is - take deposits from savers and lend them at fair (reflecting default risk) interest rates to individuals and businesses - we should also take some solace in the fact that oil prices are down more than 50% from their highs, other commodities are also down steeply and interest rates globally are likely to stay muted. Many emerging markets have seen their currencies lose significant portions of value, making easier for their manufacturers to compete in a global market place. These factors will play a role in the recovery, when it comes.