In 1983 while I was studying in the New York University (USA),I watched on TV Mr Paul Samuelson saying that Stock Exchange markets does no predict economic recessions. Later that decade, in 1987 the New York stock exchange felt down by 20% but it did not mean a recession for the American economy that year. Instead, it came about later in the beginning of the nineties and for different reasons. Does this l necessarily means that stock exchange moves on their own with no connection with the real economy? .Of course not. What about the European experience or the Latin America experience with its own stock exchange markets?.
If we take the Capital asset market pricing model, (William Sharpe, 1964)the portfolio combination maximize its short run returns based on perfect information ,frictionless markets and homogeneous risks assets. Given rational expectations, investors make decisions with all the information available in one year period. So, every unexpected event occurring during any specific year, is considered in the risk evaluation of every portfolio as a “new event” ,to make investment decisions.-
Whether there is a supply side shock (increasing oil prices) , or a demand side shocks (increasing raw materials world demand ),investors include this shocks in its asset price estimation and so on its expected total short run returns and risk evaluations. But , there is no consideration whether either it is a new trend , or a transitory shocks. Perfect information and rational expectation will solve the doubt, as long as time goes by. For instance, it seems that there is no major concerns on stocks markets with oil prices on the level of sixty dollars a barrel it has today , because markets have incorporated that shock as a trend, oil prices will continue to be higher than before , so it has charged every asset price on the proper risk magnitude that such event means for the energy cost on firms financial result. Take a look to the Air lines stock value. Most of them, have been in trouble to keep on track, unless they increase productivity, reduce cost or cut jobs. There is no another way to avoid markets bias to punish its market value . So, at this moment, it should be necessary a very high unexpected increase in oil price ,to shake financial markets .and pull them down. Every price increase within the trend , is already incorporated into the market expectations.-
Back again to the Stock exchange markets predictive power, it is clear that any economic recessions does not appear without any medium term warning signals, but stock exchange markets will consider that warnings as an isolated event , mixed with other signals either positives or negatives. Given that short run portfolios diversify risks, those warning signals induce investors to move away from the riskier sectors. So, the stock exchange markets might moves down in the economy affected by such a risk, but on the global scenario , those resources will move over to anywhere with lower economic recessions risks.-
Following the Asian crisis, foreign resources flew away from Latin America after it became clear its effect on domestic product, pushing downward the local stock exchange markets ,but pushing upwards those more secure foreign stock exchange markets. Neither stock exchange market, nor investment models predicted such a recession .
So, Stock exchange markets seeking to maximize short run portfolio returns, are not good at predicting economics recessions signalled by medium terms events ,because they always maximize short run portfolio returns rather than long run returns . The recent Dubai ´s Firm failure to move forward on the east coast American economy ports deal ,moved down the stock exchange market in Dubai, while another ones move up. Stock exchange markets looks better at reacting than predicting.-