My colleague Charles Dumas reiterates below why we remain unrepentant bulls, not least as the 3-5 year global outlook remains the best we have seen this century. Moreover Central banks obsessively chasing 2% inflation targets are likely to stoke up a true asset bubble first before the inevitable correction.
The 2018 outlook combines fine economic prospects next year with a major risk of a real-asset price bubble leading to boom/bust. Any such bust would probably be delayed well into 2019, if not 2020, so for investors the biggest 2018 risk could be the opportunity cost of not being fully invested in stocks. Only once a bubble has developed should the timing of one’s exit become paramount. This is not just a view about 2018, as the 3-5 year global outlook is the best we have seen this century.
The world is enjoying a broad advance led by three major locomotives: The US, China and north-central Europe (NCE). Inflation remains low, so the threat of seriously restrictive monetary policy is distant to non-existent. US expansion seems clearly set to broaden, as capital spending takes the baton. China’s slower first half in 2018 will be a pause for breath, to be followed by rebalanced growth. The NCE is still at most in mid-cycle with expansion driven by consumers, capital spending and exports.
Will we see the top of this cycle in 2018? ‘No’! The world economy has made a Houdini-like escape from the mid-decade threat of destructive deflation – paradoxically because of the collapse of oil and commodity prices. The terms of trade in the world economy moved decisively in favour of consumers and productive activity, and against rentiers extracting value from the ground.
What could go wrong? The biggest threat would appear to come not from bad news but from stock market euphoria in the context of out-dated monetary thinking. On our analysis, the US stock market is only a little overvalued at current levels. And the forces that have boosted it retain much power. The economies are doing well, earnings are growing, and the early stages of an upswing in the interest rate cycle usually see these factors outweighing the deterrent effects of higher rates.
Three factors at least are contributing to the surprising restraint of inflation in the face of this robust recovery: the initial and ‘echo’ effects of cheaper oil and commodities, chiefly on wages; the ongoing constraint of wage formation by global competition and hi-tech; and the direct deflationary effects of hi-tech. As a result, the natural rate of inflation in the US, continental Europe and Japan now looks pretty much like zero.
Meanwhile, monetary policies in the US and EA remain stimulative, potentially far into 2018. Real short-term US rates will remain way below their long-run average of 2%. The Fed shares the foolish quest for 2% inflation with the ECB and the BoJ, though the natural US rate is close to zero, once housing rents are excluded. Why should we want inflation at all? Raising inflation to 2% implies overheating – with its corollary of a real asset price bubble. In effect, even the Fed, and certainly the ECB and BoJ, are simply making policy less loose, not tightening in any normal sense.
The overhang of liquidity is showing the US M1 ‘Marshallian K’ – the ratio of M1 to nominal GDP, rebased to 2007 Q3. Until now all that spending power has lain dormant, as ‘animal spirits’ were crushed by the financial crisis and slow recovery – with much talk of ‘secular stagnation’. But money effects in the economy are subject to long and variable lags. As confidence grows and the medium term looks ever rosier, maybe the cash will burn a hole in people’s pockets. The price of Bitcoin may be a sign of things to come.
My colleague Oliver Brennon has re-examined our Goldilocks for longer scenario in a recent note as follows:
Previously Charles Dumas has outlined why Yellen and Draghi won’t upset global growth. So why are some investors ‘moving closer to the door’? Whilst equities simplistically look richly priced and with the S&P CAPE above 30x approaching the dotcom bubble level some nervousness is perhaps understandable. But we have argued before why the Shiller CAPE going back over 146 years is irrelevant. If we look instead at the far more pertinent post-Cold War period the CAPE’s mean is around 25 times not the oft quoted average 16.8 times of the longer period. Moreover the much more reliable S&P ‘real value’ index is only slightly above its long term trend and when the market is scaled to corporate net worth valautions are only mid-range. When policy rates start to rise CAPE will naturally fall, but in the context of improving margins and economic growth supporting earnings. Stocks may be in line for a repricing, but not necessarily a bear market triggered by overvaluation.
TS Lombard has a well established reputation for thought-leadership and being ahead of the consensus, our ideas frequently inform public debate on major issues. The ideas on this page are publically available and provide a small sample of our work. To arrange a meeting, call, or access to our non-public research please click here
Martin Shenfield, Senior Macro Strategist at TS Lombard views the recent market selloff as a healthy correction. There are 4 fundamental reasons for this:
We have a 28 year track record of successful calls. Many of these calls combined economic, political and market analysis.READ MORE