THE past three months have seen strong gains in nearly all equity markets, with the FTSE100 index recording the strongest quarter since its inception in 1984 and the US market its second strongest quarterly rise since 1960.
Although economic growth seems to have turned positive since mid-year, the speed of the upturn is being flattered by a reversal of earlier precautionary cuts in output by companies.
Although this inventory-led revival is welcome, the level of demand in many economies is still lower than a year ago. There is a risk that these output gains will not be sustained if underlying demand does not start to grow.
This could lead to a drop off in growth rates after the initial surge and, some fear, a relapse into recession.
Since there is no clear historical parallel for the economic experience of the past year, there is a wide range of views over whether the world faces prolonged stagnation, an anaemic recovery or a sharper than usual recovery.
In view of this, Central Banks and world leaders at the recent G-20 summit took pains to emphasise their willingness to keep stimulatory policies in place until the recovery is irreversibly established. The case for investing in risky assets in the spring rested strongly on their low valuation.
Although the market recovery has been disproportionate to the strength of the economic rebound, the speed and depth of the earlier falls was also indiscriminate.
This begs the question whether, if too much gloom was factored in at the lows, too much optimism might be buoying investors along now.
Although 2010 is likely to have a more hopeful starting point than 2009, economic decision-making will be harder, as this year’s overwhelming priority to restore confidence gives way to more complex judgements about normalising interest rates and fiscal policy.
It is possible that 2010 will present problems of controlling a stronger than expected upswing, bringing forward fiscal and monetary tightening. In that event, the economy might have a smoother ride than financial markets.
More likely is continued, gradual economic healing and positive, though less rapid than in 2009.