London - You don't need to have been an avid follower of financial markets to appreciate that they have not had a great start to the year.
Indeed, it has been the worst for UK shares since 2000; for European shares, the worst for 40 years. George Soros fears there is more to come. “When I look at the financial markets, there is a serious challenge which reminds me of the crisis in 2008,” the billionaire investor and philanthropist told an economic forum in Sri Lanka last week. George Osborne, meanwhile, has moved a long way from his heralding of the UK as the fastest-growing economy in the G7 last November to warning of “dangerous complacency” and a “cocktail of threats”.
That gloom is reflected in comments from a number of professional advisers. Andrew Roberts, head of credit at Royal Bank of Scotland, has gone further than most and warns of a “cataclysmic” year for markets. He predicts that European and US shares will fall by 10 to 20 per cent this year, while the fall in the UK could be even more severe. As for the oil price, Morgan Stanley, the US investment bank, thinks that it will slide down towards $20 a barrel.
What should we make of this? There has certainly been a rapid shift of mood, but is it a shift of substance? And since we know that markets are prone to sudden swings, does what happens to them matter to the real economy, as measured by output of goods and services and the number of jobs it creates?
The first thing to be clear about is that while there is a link between markets and the real economy, it is tenuous. A sudden collapse of share prices may indicate that there is recession ahead, as it did dramatically from the end of 2007 through 2008. But although the fall during 2000, when the dot-com bubble popped, did signal an economic slowdown, many countries, including the UK, escaped recession. As for the famous “Black Monday” collapse in October 1987, the boom had still another two years to run. These market cycles are similar, but they are never quite the same.
Still, some things can be said with confidence about both the current market gyrations and the underlying world economy. Both have had long, if uneven, booms. Both have been propped up by unprecedentedly easy money, which in the US, at least, is now coming to an end. In markets you have to distinguish between financial instruments and commodities: equities reflect optimism for future profitable growth, bonds reflect inflation and policy expectations, and commodities reflect supply and demand for the products.
With global equities, the core issue is whether companies can expect continued profitable demand. Sentiment will swing and as a result the valuations will swing. But if the world economy keeps growing and if they carry on making profits, they will continue to pay dividends and that will underpin share values.
You can see concern about maintaining dividends reflected in prices right now. The sectors hit hardest have been the mining companies and the oil majors. The UK market is heavily weighted towards them.
Overall, however, if you believe that the economy will grow, then shares will recover. That is the position of Goldman Sachs, which is particularly optimistic about Europe. It expects European shares to rise by 18 per cent in 2016, double the US increase. Its basic message is that share prices have fallen so much there is value to be had in a way there wasn't last summer. So no apocalyptic warnings here - but then Goldman Sachs has been relatively optimistic in recent years.
For bonds the key is inflation. The years of near-zero interest rates and QE have created asset inflation, as we see in UK house prices, but no regular consumer inflation, at least not yet. So bond yields have remained depressed. Gradually some markets are moving back to more normal levels. On Tuesday, US ten-year Treasury bonds were yielding 2.2 percent, low, but not ridiculously so. The equivalent German bonds yielded just over 0.5 percent, not much of a return if the European Central Bank succeeds in getting inflation up to its target of close to 2 percent. If the next decade is one of stagnant European growth, then maybe this would make sense. But for those of us who believe that Europe will not become the new Japan, it seems pretty odd.
For commodities and energy, the key is China. The saying “if the US sneezes, Europe catches a cold” probably still applies, but the rise of China - not only to become the world's second-largest economy but to be its largest importer of oil and other commodities - has complicated matters. It is not quite a “if China sneezes the world catches a cold” situation, but China's sneeze - its slowdown in growth - has given oil and commodity markets pneumonia. The fall in the oil price should give a net boost to the world economy, just as those oil shocks of the past gave a net hit. But in the short-term the negatives are specific and obvious, while the positives are general and nebulous.
The message of the markets may be ambiguous, disconnected and confused, but it shows a concern that there may be a recession on the horizon but, on balance, thinking that there probably won't be.
We know that there is a global economic cycle from which we seem to be unable to escape. We know too that downturns seem to occur every eight to 10 years, which would suggest one is due soon. And we know that the world economy is carrying a huge burden of debt. On the other hand, the normal signs of strain that precede a recession are not evident, suggesting that if there is a downturn it will not be a particularly serious one, certainly not as serious as the last. I don't believe there is a “dangerous complacency”. There might have been a few months ago, but not now - and that perhaps is the best news of all.