With
share prices around the world setting new records almost daily, it is
tempting to ask whether markets have entered a period of “irrational
exuberance” and are heading for a fall. The answer is probably no.
What
many analysts still see as a temporary bubble, pumped up by artificial
and unsustainable monetary stimulus, is maturing into a structural
expansion of economic activity, profits, and employment that probably
has many more years to run. There are at least four reasons for such
optimism.
First and foremost, the world economy is firing on all
cylinders, with the United States, Europe, and China simultaneously
experiencing robust economic growth for the first time since 2008.
Eventually, these simultaneous expansions will face the challenge of
inflation and higher interest rates. But, given high unemployment in
Europe and spare capacity in China, plus the persistent deflationary
pressures from technology and global competition, the dangers of
overheating are years away.
Without hard evidence of rapid inflation,
central bankers will prefer to risk over-stimulating their economies
rather than prematurely tightening money. There is thus almost no chance
of a quick return to what used to be considered “normal” monetary
conditions – for example, of US short-term interest rates rising to
their pre-crisis average of inflation plus roughly 2%.
Instead, very
low interest rates will likely persist at least until the end of the
decade. And that means that current stock-market valuations, which imply
prospective returns of 4% or 5% above inflation, are still attractive.
A
second reason for confidence is that the financial impact of zero
interest rates and the vast expansion of central bank money known as
“quantitative easing” (QE) are now much better understood than they were
when introduced following the 2008 crisis. In the first few years of
these unprecedented monetary-policy experiments, investors reasonably
feared that they would fail or cause even greater financial instability.
Monetary stimulus was often compared to an illegal performance drug,
which would produce a brief rebound in economic activity and asset
prices, inevitably followed by a slump once the artificial stimulus was
withdrawn or even just reduced.
Many investors still believe the
post-crisis recovery is doomed, because it was triggered by
unsustainable monetary policies. But this is no longer a reasonable
view. The fact is that experimental monetary policy has produced
positive results. The US Federal Reserve, which pioneered the
post-crisis experiments with zero interest rates and QE, began to reduce
its purchases of long-term securities at the beginning of 2014, stopped
QE completely later that year, and started raising interest rates in
2015 – all without producing the “cold turkey” effects predicted by
skeptics.
Instead of falling back into recession or secular
stagnation, the US economy continued growing and creating jobs as the
stimulus was reduced and then stopped. And asset prices, far from
collapsing, hit new highs and accelerated upward from early 2013 onwards
– exactly when the Fed started talking about “tapering” QE.
The
Fed’s policy experimentation points to a third reason for optimism. By
demonstrating the success of monetary stimulus, the US has provided a
roadmap that other countries have followed, but with long and variable
lags. Japan started full-scale monetary stimulus in 2013, five years
after the Fed. Europe lagged by seven years, starting QE in March 2015.
And in many emerging economies, monetary stimulus and economic recovery
only began this year. As a result, business cycles and monetary policy
are less synchronised than in any previous global expansion.
That is
good news for investors. While the Fed is raising interest rates, Europe
and Japan are planning to keep theirs near zero at least until the end
of the decade, which will moderate the negative effects of US monetary
tightening on asset markets around the world, while European
unemployment and Asian overcapacity will delay the upward pressure on
prices normally created by a co-ordinated global expansion.
This
suggests the fourth reason why the global bull market will continue.
While US corporate profits, which have been rising for seven years, have
probably hit a ceiling, the cyclical upswing in profits outside the US
has only recently started and will create new investment opportunities.
So, even if US investment conditions become less favourable, Europe,
Japan, and many emerging markets are now entering the sweet spot of
their investment cycles: profits are rising strongly, but interest rates
remain very low.
All of these cyclical reasons for optimism are, of
course, challenged by long-term structural anxieties. Can low interest
rates really compensate for rising debt burdens? Is productivity really
falling, as implied by most economic statics, or accelerating, as
technological breakthroughs suggest? Are nationalism and protectionism
poised to overwhelm globalisation and competition? Will inequality be
narrowed by job creation or widen further, causing political upheaval?
The
list could go on and on. But these structural questions all have
something in common: We will not know the true answers for many years.
One thing we can say with confidence, however, is that market
expectations about what may happen in the long term are strongly
influenced by short-term cyclical conditions that are visible today.
During
recessions, investor opinion is dominated by long-term anxieties about
debt burdens, aging, and weak productivity growth, as has been true in
the period since 2008. In economic upswings, psychology shifts toward
the benefits of low interest rates, leverage, and technological
progress.
When this optimistic shift goes too far, asset valuations
rise exponentially and the bull market reaches a dangerous climax. Some
speculative assets, such as cyber currencies, have already reached this
point, and shares in even the best public companies are bound to
experience temporary setbacks if they run up too fast. But for stock
markets generally, valuations are not yet excessive, and investors are
far from euphoric. So long as such cautiousness continues, asset prices
are more likely to rise than fall. - Project Syndicate
* Anatole
Kaletsky is Chief Economist and Co-Chairman of Gavekal Dragonomics and
the author of Capitalism 4.0, The Birth of a New Economy.
The world economy is firing on all cylinders, with the United States, Europe, and China simultaneously experiencing robust economic growth for the first time since 2008.