Many economists befuddled by markets’ deep dive

If you look only at the global economy, and what leading forecasters think it will do in 2016, things look to be in a reasonably solid state. The world economy will grow 3.4 percent this year, economists at the International Monetary Fund projected this week, up from 3.1 percent in 2015. Private-sector forecasters mostly have similar expectations.

But if you look only at global financial markets, it’s “Aaack, run for the hills! The sky is falling!”

That is to say, global stock, bond and especially commodity markets have, in the first three weeks of the year, swung in ways that suggest this is a perilous time. Their volatility and direction are consistent with the prospect of a new crisis or global recession. (The Standard & Poor’s stock index closed down 1.2 percent Wednesday after dropping more than 3 percent earlier in the day.)

The price of oil is where the most action is, with West Texas Intermediate trading below $27 a barrel Wednesday, down from around $37 at the end of December, $60 in June and $100 in mid-2014.

The broad S&P is down more than 9 percent so far in 2016, and stock indexes in many emerging economies are down even more. Bond and currency markets point to economic troubles in oil-producing nations.

(Considering a trip to Canada? Good move. The Canadian dollar is down 19 percent against the U.S. dollar since May.)

What makes these falling prices unnerving is that it is hard to tell a simple story about what is driving them.

It could be that the markets are moving according to their own logic, driven by money managers’ psychology, with their habitual toggle between fear and greed turning back toward the former.

More frightening: The markets could be pricing in some darker facts about the outlook for the world that economists do not fully understand.

In the past, when signals were so negative, there usually was a clearer story to tell.

In the summer and fall of 2011, markets were tumbling on fears that the union using the euro currency would dissolve; in 2008, it was fears that the global financial system would collapse; in 2000 it was on the realization that stock prices, especially for technology companies, had gotten out of line.

The recent market swings are “puzzling,” writes Olivier Blanchard, until recently the chief economist of the International Monetary Fund and now a senior fellow at the Peterson Institute for International Economics.

As a general rule, if Blanchard is puzzled about something involving global economics, you probably should be, too.

• China’s once-blockbuster economic growth does seem to have slowed a good deal, though it is not clear why that should have enormous effects outside China.
• Oil prices are down so much that profits of oil companies will suffer mightily, and some will surely go bankrupt. They have already been cutting way back on investment in oil exploration. But historically, that has been counterbalanced by celebrations from industrial and transportation companies and from ordinary people over lower bills for gasoline, heating oil and other forms of fuel.
• There is a more complex story in which global banks are sitting on loans for oil exploration that will go bad, creating losses in the financial sector that could cause a pullback in lending more broadly, a risk described by researchers at the Bank for International Settlements in 2015.

In this scenario, loans for oil exploration could be what subprime mortgages were in 2007 — a trigger that reveals bigger problems in the financial system.

One piece of evidence for this theory: Bank stocks have fallen even more in 2016 than the stock market overall, implying that investors believe banks did a little too much oil-field lending, though certainly this will not amount to the kinds of declines and major troubles of 2008.

Another possibility is that this sell-off reflects the unwinding of “herd” behavior among global asset managers, who piled into similar investments during the stock market rally of 2009-2014 and are now racing to unload the same high-yield bonds, emerging-market stocks and energy investments all at once.

In this telling, the moves in market prices reflect more the psychology of money managers than fundamental information about the state of the global economy.

This latter theory is the most optimistic one (and one Blanchard is particularly sympathetic to, for what that’s worth).

Financial markets are always more volatile than the underlying economy; the stock market has predicted nine of the last five recessions, as an old line often credited to the economist Paul Samuelson has it.

At the same time, sometimes markets know something that smarty-pants economists, or economic writers, don’t. It was certainly true in the fall of 2007, when the stock and bond markets were more prescient about the looming recession in the United States than the consensus view of economists.

The challenge for investors is to determine whether the stock-market moves of the last few weeks represent the rational kind of fear or the irrational kind of fear, and we probably will not know the answer anytime soon.