There is an uncanny relationship between the US and the UK stock markets.
It seems that when the Dow Jones Industrial Index rises then so too does the FTSE. Similarly, when the Dow takes a bath, the FTSE 100 also gets a soaking.
Experts call this coupling. Proponents of coupling believe that the economies of the world are somehow inextricably linked. Consequently, a slowdown in America can have a direct impact on economies elsewhere in the world, too. There was a time when some economists believed that European and Asian economies had broadened and deepened sufficiently so that they no longer depended on the US for growth. They called it decoupling to reflect the fact that economies can be separated. The premise was that if the US should slip into recession, the rest of the world might be insulated from a slowdown.
However, the decoupling theory has been blown apart by the recent recession. In 2008 when fears of recession surfaced in America, the value of US shares dropped precipitously. The Dow fell from about 14,000 points to about 6,500 points – a drop of almost 50 per cent. In the UK, the FTSE echoed this decline: it fell from about 6,700 points to 3,500 points – a similar drop in percentage terms.
Now that the US is on the mend, the Federal Reserve looks set to pump more money into the economy, which could increase the rate of inflation. In response, the Dow Jones has popped its head above the 11,000 level once again. However, do not underestimate quantitative easing. When money is added to an economy, it not only finds its way into consumers' pockets but also into equities. Since UK shares have been dancing to the US tune for years, there is no reason to suppose it will stop now.
David Kuo is director of financial website fool.co.ukReuse content