Market instability comes at an inconvenient time for Canada's financial industry: Don Pittis

As Canada's gross domestic product chalked up strong gains, a chat with an acquaintance this week reminded me that smart people don't necessarily realize that financial markets and the economy are not quite the same thing.

And, perhaps counterintuitively, signs of a strong economy could turn out to be bad news for Canada's financial industry, currently gearing up for what is often called RRSP season.

Wednesday's GDP numbers were just one more indicator that the Canadian, the U.S. and the world economy is showing distinct signs of health.

Rising wages

In fact, in his state of the union address on Tuesday, U.S. President Donald Trump bragged about the strength of the U.S. economy.

"Since the election, we have created 2.4 million new jobs, including 200,000 new jobs in manufacturing alone," said Trump. "After years of wage stagnation, we are finally seeing rising wages."

Trump's opponents in the Democratic Party like to claim that jobs boom for the previous administration of Barack Obama, but no one disputes that the U.S. economy is on a tear. And if wages continue to rise, Trump could be on his way to fulfilling a commitment to improve the lives of disgruntled workers who voted for him.

That jobs boom is expected to continue when U.S. employment numbers come out Friday. Canada's aren't out till the following week.

The jobless rate in the U.S. is now actually below the level that many economists set for "full employment" — the notional level where everyone who wants a job can get one.

In his speech, Trump also crowed about the state of the stock market that, contrary to the predictions of many doomsayers immediately after his election, has soared from strength to strength.

"The stock market has smashed one record after another, gaining $8 trillion in value," boasted Trump. 

Falling stocks

Of course, the irony was that as he was speaking, U.S. stock markets had just had their worst two-day slump in the Trump presidency. The second irony is that the market slump could be blamed quite firmly on the previously mentioned economic strength.

And this is the thing that can be confusing: that stocks, bonds and economic health, while related, do not follow the same path.

In the long run, there is no question that a strong economy is essential for strong financial markets. It is just that they are not synchronized.

What we've seen is a healthy economy beginning to force central banks to cut back on monetary stimulus.

• Fed leaves rates unchanged, sees inflation rising this year 

In an article titled U.S. stocks slide as bond sell-off rattles investors this is how Britain's Financial Times described what was happening.

"Rising bond yields make borrowing more expensive, potentially straining some companies that have been relying on cheap money to grow, and also make equities look relatively less attractive," wrote the FT reporters.

To make the steps in the relationship just a little clearer, as the economy strengthens, central banks pump less money into it, pushing interest rates higher, making existing bonds worth less and making it harder for companies and individuals to invest with cheap borrowed money. 

And there is another disconnect between markets and the broader economy, between Wall Street and Main Street.

Workers' fair share 

As Democratic representative Joe Kennedy (yes, of that Kennedy clan) pointed out in his response to Trump's speech, nearly 10 years of rising stocks and bonds have not given working people a similar raise.

"We see an economy that makes stocks soar, investor portfolios bulge and corporate profits climb but fails to give workers their fair share of the reward," said Kennedy.

Many analysts have observed with concern that since the 2007-2008 financial crisis, each time central banks added money to boost a sagging economy, stock and bond markets repeatedly surged.

As some commentators, including Yale economist Robert Shiller, have remarked, markets have demonstrated a trajectory similar to that in the 1920s, when the rich got richer while the underlying economy became unstable. Smart people don't want that to happen again.

This week's market decline was a reminder to investors that investments don't just go up. Rising markets can cover a host of ills, so if stocks and bonds continue their slide, there could be further investor uncertainty ahead.   

Also, if this week's market decline is more than a blip, it will make the job harder for Canadian financial institutions trying to get nervous investors to put money into registered retirement saving plans before the end of the tax year.

Everyone knew that the inflection point where interest rates change direction was going to be bumpy. 

But a strong economy that includes more and better jobs, that includes higher wages and a bigger share going to the people who don't own stocks and bonds, is essential to future financial returns.

In a modern integrated economy, well-employed workers form the base of the pyramid on which financial markets are built. Workers consume the products that companies make to earn their profits. And without those companies there would be no products for the workers to consume.

For investors considering the long term, a healthy real economy with a healthy job market is the guarantee that, whatever happens in the short term, their investments will continue to hold real value into the future.

Follow Don on Twitter @don_pittis

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