The "slump" in share prices reminds me of a curious correlation - the strong link in recent years between equity returns and US economic growth.
I say "curious" because this link shouldn't exist. Markets should see recessions coming and mark down share prices in advance of them; how hard can it be to just (pdf) look at the yield curve? So why should shares fall during recessions?
Yesterday's big price falls add to this puzzle. The papers say these were triggered by news of Citigroup's troubles. But this won't do. Any fool could tell weeks ago that banks had yet to annouce the full losses on mortgage securities. And the dividend cut was anticipated long ago.
Nor is it plausible that the drop in December's US retail sales should come as a huge surprise. The real surprise about retail sales is how strong they've been recently given the weakness of the housing market - up 5.2 per cent excluding autos albeit in nominal terms in the last 12 months. In this context, December's fall, as James says, is only mildly disappointing.
So, why should the market have fallen so much yesterday, and be so sensitive to contemporaneous moves in industrial output?
It can't be solely because American investors and especially equity analysts have an optimism bias that blinds them to the possibility of earnings shortfalls or recession. My chart shows that strong economic growth in the late 90s and in 2004-05 was as good for shares as weak growth was bad.
So, here's my theory. Investors are terrible at is predicting their future tastes; see this great paper (pdf). They might - or at least should - be able to forecast economic upswings and downswings. What they don't foresee is the impact these will have upon their appetite for risk. They don't see that bad economic times will cut their appetite for risk and that good times will raise it. The upshot is that shares fall in bad times even if such times should be foreseeable.
There's a lesson here beyond the triviality of short-term market moves. If people are bad at predicting their future tastes, even when billions of pounds are at stake, doesn't this suggest that our ability to make choices that make us happy might be severely limited?