Is the Market Shrugging Off Sudden Economic Shocks?

How does the market react when commodity prices begin to rise steeply, a region of the world becomes unstable, and a massive earthquake shapes one of the worlds most important economies? Apparently, it shrugs in disinterest. That's the contention in a Bloomberg article today by John Detrixhe. He notes that, despite all of these "black swans," a popular term for unforeseen economic shock, the market just keeps rising. What's causing its resilience?

The Money Report

The Market Has Not Fully Recovered

For starters, it's important to note that the market has not recovered to reach its pre-recession levels. For example, the S&P500 stock index must rise more than 20% to reach its October 2007 high of $1,565. Meanwhile, however, other measures of economic activity have fully recovered. Inflation-adjusted annualized GDP hit a new high in the fourth quarter at $13.37 trillion, surpassing its fourth quarter 2007 value of $13.36 trillion. Retail sales are also hitting new highs this year. So economic activity and consumer demand have returned to their pre-recession levels, but the market has not. That's because new risks persist that weren't present in 2007. It's likely that stocks could have recovered even more quickly if new risks didn't surface this year.

Black Swans Not Completely Ignored

And that brings up the next point -- the black swans did have some effect. Here's a chart showing the S&P500 since November. The red line is actual performance; the green line is a world without the economic shocks that hit over the past few months (where big declines were taken out):

s&p black swans 2011-03.png

In fact, the S&P could be as much as 12% higher without these shocks. Now, granted, the increases might not have been as substantial without the declines. So the real outcome without the Black Swans probably would have been somewhere in between these two lines -- but the market would certainly be higher. For example, yesterday the market rose in part due to good news out of Japan, but other news the market interpreted as positive also helped. So these shocks are having an effect: they're slowing stock market growth to some extent.

Not Bad Enough to Cause a Double Dip

Yet the black swans are obviously not severe enough to cause the market to believe the recovery will fail entirely. If they were, then you would see a great deal of investment exit the stock market, as a double dip could result. This actually makes sense if you consider each shock separately.

Commodity Price Increases

To be sure, energy and food prices are a worry for the recovery. But at this point, they haven't risen by enough to endanger it. For example, oil prices were actually higher a few years ago, so we aren't exactly in uncharted territory yet. If these prices do continue to rise past historical highs, however, then the market will begin to worry.

Unrest in the Middle East and Northern Africa

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Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.

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