Go with the flow

Markets: Love, they say, is fickle. The investor passion for easy money may yet fade. But this affair could run for a while.

The recent outbreak of investor enthusiasm — European and US stock markets up 5 per cent or so less than two weeks — might have something to do with the real economy. But the recent news is hardly the stuff of exuberance.

Cuts in costs and jobs have helped keep corporate profits up to snuff, but mobile phone operator Vodafone’s description of Europe — which “continues to experience economic pressure” — applies to most of the world. There’s a recovery underway, but it’s shaky and propped up by ultimately unsustainable fiscal and monetary largesse.

Actual easy money is a better explanation than economic hope for the increasing prices of all sorts of financial assets. In the last month gold has risen by 5 per cent oil is up 9 per cent and European investment grade debt spreads have narrowed by 14 per cent (that means higher prices for loans). Even UK house prices are creeping higher.

There is an irony here. The authorities keep pouring money into the economy because they fear a relapse into deep recession, deflation and another financial crisis. But the money flows into financial markets are making many asset prices rise just as if a strong and possibly inflationary recovery were at hand.

The most recent prod was the lack of optimism at the meeting of G20 finance ministers over the weekend. Investors were delighted to hear that politicians and central bankers are still too gloomy to think about an “exit strategy” from their unprecedented deficits and monetary stimulus programmes.

The economy could yet justify this paradoxical market rally, if the still-weak green shoots of recovery take root over the winter. Alternatively, if the recovery founders, investors could, like jealous lovers, turn against their favourite. They might decide that too-easy money had debased currencies and soured long-term prospects.

For the next few months, though, the mechanical effect of the cheap money flowing into asset markets is likely to prevail over any such fears. The financial recovery still looks to be in place.