An earlier post compared the path of world equity prices in the current economic downswing with average experience in six “soft” and six “hard” landings over the last 40 years. At the time of the post equities were following the historical soft landing path closely.

The first chart below updates the analysis to take account of the recent market plunge (the latest data point refers to Friday’s close). Sentiment has clearly shifted, with current prices implying a high risk of a hard landing. This fits with other evidence of increased economic bearishness: for example, the Intrade US recession probability contract has risen to 70%.

While markets have moved to discount a hard landing, monetary conditions have been easing. As shown by the second chart, our monetary leading indicator picked up further in early January, reflecting lower LIBOR rates. Near-term economic weakness is baked in the cake but monetary factors will be lifting activity later in 2008 and in 2009.

The US economy may yet avoid a recession. The third chart shows that business inventories normally rise significantly before recessions start but are currently at a record low relative to sales. Weekly jobless claims are still averaging less than 350,000 – a rise towards 400,000 is needed to confirm a contraction.

Recession fears focus on the housing market and consumer spending. Interestingly, the S&P homebuilding index held above its early January low amid last week’s equity market carnage. Wal-Mart’s share price – which tends to correlate with retail sales – also remains strangely resilient.

Even if a hard landing is confirmed, the first chart suggests equity markets should find support not far from current levels. Additional considerations are moderate valuations and plentiful global liquidity. Of course, the hard landing average includes some larger declines – nothing is guaranteed – but equities look increasingly attractive in risk / reward terms.