A foretaste of a new phase in the markets

It is better to travel hopefully than to arrive. For weeks data on the American economy had been patchy, indicating a spluttering recovery. Unemployment in particular continued to rise, hitting 10.2 per cent in October. Have patience, said the optimists. Unemployment is a lagging indicator. Sure enough, on December 4 the non-farm payrolls data for November showed a fall of 11,000 jobs, a far smaller figure than expected. The last jigsaw-piece of recovery had slotted into place.

You might have expected the stock market to rebound sharply on the news. After all, a rise in employment can make the recovery self-sustaining. The economy can be less dependent on ad hoc government schemes like "cash for clunkers". But the Dow Jones Industrial Average eked out a mere 22-point gain on the day of the announcement.

Improving trend

Admittedly the data were not uniformly bullish. One reason why the headline unemployment rate fell to 10 per cent last month was because discouraged workers dropped out of the numbers since they were no longer looking for a job. Nevertheless, increases in hours worked and temporary employment suggested the improving trend will continue.

This may have been another case of "buy the rumour, sell the fact". Stock markets have been rallying since March on anticipation the global economy would recover. Now the news is confirmed, some investors may have decided it was time to take a profit.

After all, one of the main motors of the rally has been near-zero interest rates in the rich economies. These have driven investors out of cash and into riskier assets, including corporate bonds and equities. But the justification for such low rates has been the fragile state of the economy. Proof of a recovery will bring forward the day when easy money is withdrawn.

Indeed, after the news, markets moved to price in the first Federal Reserve rate hike in June 2010. Higher rates are not the only implication of a better employment market. David Rosenberg, a strategist at Gluskin Sheff, a Canadian asset-management firm, adds the stock market may have become used to treating negative employment news as positive for corporate costs and profit margins. If firms start hiring workers again, these productivity gains may slow.

Investors may also begin to worry more about the strain on government finances that has been imposed by the crisis. A report from Moody's earlier this month described the American and British public finances as "resilient", rather than the more solid "resistant" categorisation afforded to Canada and Germany. Continuation of America's and Britain's AAA ratings depends on credible fiscal consolidation. Greece was downgraded on December 8 by Fitch, a rival rating agency, from A- to BBB+, prompting falls in Greek shares and government bonds.

If 2008 was the year of the banking meltdown, then 2009 was the year of the stimulus packages. In contrast, 2010 may be the year of the exit strategies, in which investors have to contemplate what economic (and market) fundamentals look like without massive government support. Many countries may have hoped to get through 2010 without withdrawing that support but markets could force them into action, by pressuring either their bonds or their currencies.

The immediate aftermath of the payrolls data may have offered a brief glimpse of that future. The dollar rose.

Bullion

This could have been due to the anticipation of higher interest rates giving the currency yield support in 2010, or it may have been due to the inverse relationship between the dollar and risky assets this year. Investors have been borrowing in dollars to buy higher-yielding assets.

Meanwhile gold fell in response to the payrolls news. This makes little sense if gold is supposed to act as a hedge against rising inflation: evidence of a stronger economy should make bullion rise, not fall. But it makes perfect sense if you see gold as an alternative currency to the dollar, rising when the greenback declines and vice versa.

Gold's fall could be an omen in another way, too. During the rally, almost all assets rose in tandem. During 2010 there may be a lot more differentiation.