City: When the sun shines, shares catch a cold

TO ORDINARY people, the ways of the stock market must seem strange and perverse indeed. Last week, Wall Street fell heavily from record levels, prompting by Friday a near rout in markets around the world. The cause? Some positive US economic news.

Yes it's true: good news on the economy seems to be bad news for share prices.

Stock markets are meant to be long-term lead indicators of what's happening in the real economy and thus broadly counter-cyclical; when the economy is going one way, the stock market should be going the other in anticipation of the next stage of the cycle.

The logic behind last week's correction in share prices goes something like this. Confirmation that the US economy is finally improving means a return of inflationary pressures, which in turn might prompt governments to start raising interest rates. Bonds fell accordingly and caused equities, which have been driven to record levels by the low interest rate environment, to follow.

Yet even to professionals, the market's behaviour must seem a little odd. Evidence of renewed growth in the US hardly means an immediate return to rip-roaring inflation. Interest rates may have bottomed out, but they hardly look set to rise by very much for some time yet.

Investors are clearly edgy and nervous; who wouldn't be after the bull run of the past year? We may be in for some quite severe turbulence over the next week or two, but it's hard to believe it will turn into a crash or long-term bear market quite yet.