Today’s rational exuberance

Withshare prices around the world setting new records almost daily, it istempting to ask whether markets have entered a period of “irrationalexuberance” and are heading for a fall. The answer is probably no.Whatmany analysts still see as a temporary bubble, pumped up by artificialand unsustainable monetary stimulus, is maturing into a structuralexpansion of economic activity, profits, and employment that probablyhas many more years to run. There are at least four reasons for suchoptimism.First and foremost, the world economy is firing on allcylinders, with the United States, Europe, and China simultaneouslyexperiencing robust economic growth for the first time since 2008.Eventually, these simultaneous expansions will face the challenge ofinflation and higher interest rates. But, given high unemployment inEurope and spare capacity in China, plus the persistent deflationarypressures from technology and global competition, the dangers ofoverheating are years away.Without hard evidence of rapid inflation,central bankers will prefer to risk over-stimulating their economiesrather than prematurely tightening money. There is thus almost no chanceof a quick return to what used to be considered “normal” monetaryconditions – for example, of US short-term interest rates rising totheir pre-crisis average of inflation plus roughly 2%.Instead, verylow interest rates will likely persist at least until the end of thedecade. And that means that current stock-market valuations, which implyprospective returns of 4% or 5% above inflation, are still attractive.Asecond reason for confidence is that the financial impact of zerointerest rates and the vast expansion of central bank money known as“quantitative easing” (QE) are now much better understood than they werewhen introduced following the 2008 crisis. In the first few years ofthese unprecedented monetary-policy experiments, investors reasonablyfeared 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 assetprices, inevitably followed by a slump once the artificial stimulus waswithdrawn or even just reduced.Many investors still believe thepost-crisis recovery is doomed, because it was triggered byunsustainable monetary policies. But this is no longer a reasonableview. The fact is that experimental monetary policy has producedpositive results. The US Federal Reserve, which pioneered thepost-crisis experiments with zero interest rates and QE, began to reduceits purchases of long-term securities at the beginning of 2014, stoppedQE completely later that year, and started raising interest rates in2015 – all without producing the “cold turkey” effects predicted byskeptics.Instead of falling back into recession or secularstagnation, the US economy continued growing and creating jobs as thestimulus was reduced and then stopped. And asset prices, far fromcollapsing, hit new highs and accelerated upward from early 2013 onwards– exactly when the Fed started talking about “tapering” QE.TheFed’s policy experimentation points to a third reason for optimism. Bydemonstrating the success of monetary stimulus, the US has provided aroadmap that other countries have followed, but with long and variablelags. Japan started full-scale monetary stimulus in 2013, five yearsafter the Fed. Europe lagged by seven years, starting QE in March 2015.And in many emerging economies, monetary stimulus and economic recoveryonly began this year. As a result, business cycles and monetary policyare less synchronised than in any previous global expansion.That isgood news for investors. While the Fed is raising interest rates, Europeand Japan are planning to keep theirs near zero at least until the endof the decade, which will moderate the negative effects of US monetarytightening on asset markets around the world, while Europeanunemployment and Asian overcapacity will delay the upward pressure onprices normally created by a co-ordinated global expansion.Thissuggests the fourth reason why the global bull market will continue.While US corporate profits, which have been rising for seven years, haveprobably hit a ceiling, the cyclical upswing in profits outside the UShas 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 oftheir investment cycles: profits are rising strongly, but interest ratesremain very low.All of these cyclical reasons for optimism are, ofcourse, challenged by long-term structural anxieties. Can low interestrates really compensate for rising debt burdens? Is productivity reallyfalling, as implied by most economic statics, or accelerating, astechnological breakthroughs suggest? Are nationalism and protectionismpoised to overwhelm globalisation and competition? Will inequality benarrowed by job creation or widen further, causing political upheaval?Thelist could go on and on. But these structural questions all havesomething in common: We will not know the true answers for many years.One thing we can say with confidence, however, is that marketexpectations about what may happen in the long term are stronglyinfluenced by short-term cyclical conditions that are visible today.Duringrecessions, investor opinion is dominated by long-term anxieties aboutdebt burdens, aging, and weak productivity growth, as has been true inthe period since 2008. In economic upswings, psychology shifts towardthe benefits of low interest rates, leverage, and technologicalprogress.When this optimistic shift goes too far, asset valuationsrise exponentially and the bull market reaches a dangerous climax. Somespeculative assets, such as cyber currencies, have already reached thispoint, and shares in even the best public companies are bound toexperience temporary setbacks if they run up too fast. But for stockmarkets generally, valuations are not yet excessive, and investors arefar from euphoric. So long as such cautiousness continues, asset pricesare more likely to rise than fall. - Project Syndicate* AnatoleKaletsky is Chief Economist and Co-Chairman of Gavekal Dragonomics andthe author of Capitalism 4.0, The Birth of a New Economy.