June 07, 2002

A popular theme among financial analysts is the apparent disconnect between the economic recovery and the financial markets. Manufacturing is on the rebound, residential construction is at a record high, inventories are low, productivity growth is really good and there is no inflation. What could be better? Yet you could not tell that by looking at the recent behavior of the stock market. A clear disconnect between the economy and the markets is apparent. Since most people agree that the disconnect cannot go on forever, at some point in time the economy and financial markets performance must converge. The big question is who will do the converging. Will the economy adjust to reflect the financial markets performance? Or will the financial markets turn around to reflect the economic recovery? While we do not share the bearish case, it is easily made. The market woes presage a double dip and some hard times ahead. We would like to consider two other cases. While not completely bullish they suggest that the current problems are temporary. However, the two alternatives have vastly different long-run implications. (full article attached)

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