I visited with some of our institutional accounts in New England last week. I am sensing that a consensus is emerging among them and our other accounts in the US and abroad.
They are less concerned about frothy valuation multiples in stocks, and less bearish on bonds than they were earlier this year. They are much less concerned about the Fed too, figuring that rate hikes will remain very gradual and that the central bank won’t shrink its balance sheet for a while.
In any event, they see better values in European and EM stock markets. They have mixed views on the FAANGs.
No one was able to come up with any new and credible black-swan event that might trip up the bull market in stocks. I observed that white swans typically outnumber black ones over time. We all agreed that one possible perverse black swan might be a melt-up that leads to a meltdown. Investors increasingly are either irritated or bored with the daily swamp opera in DC, and mostly tuning it out. There usually aren’t any swans of any color in swamps, just too many swamp people and alligators. Investors aren’t betting the farm on Trump’s economic agenda. If a significantly downsized version is eventually enacted, that’s okay. If nothing changes, so be it. There’s plenty to keep the bull charging ahead.
Investors seem to be coming around to our long-held view that this economic expansion could last for a very long time. In other words, they are considering the possibility that the biggest surprise might be how long the current bull market lasts. In this scenario, both inflation and interest rates would remain surprisingly low for a surprisingly long time. Valuation multiples might stay high for a long time too. Again, historically speaking, white swans tend to outnumber black swans.
Debbie and I have been arguing that the Trauma of 2008 reduced the likelihood of a boom-bust scenario for the economy as both consumers and businesses remained relatively cautious and conservative in their spending and borrowing activities. Among the most telling confirmations of our hypothesis is that wage inflation, as measured by the yearly growth rate in average hourly earnings, remains around 2.5%. In the past, the current record number of job openings and the cyclical low in consumers reporting that jobs are hard to get was associated with wage inflation of 3.0%-4.0% or higher (Fig. 1 and Fig. 2). This is consistent with our NBx2 scenario, i.e., No Boom, No Bust.
About two and a half years ago, back on October 27, 2014, Debbie and I first discussed the possibility that the current economic expansion might last until March 2019. That was based on a simple benchmark model of the business cycle. We noted that during the previous five business cycles, the recovery periods lasted 26 months on average, measured from the trough of the Index of Coincident Economic Indicators back to the previous cyclical peak (Fig. 3). The remaining expansion phases lasted 65 months on average after the recovery phase. That would put the next cyclical peak during March 2019.
Traditional business-cycle economists have been expecting tighter labor market conditions to boost wages, which would lift price inflation. This is based on the classic demand-pull and cost-push models of inflation, including the Output Gap and Phillips Curve. These inflation models don’t recognize the possibility that there may be powerful secular forces keeping a lid on price inflation, which keeps a lid on wage demands even in a tight labor market. These forces include competition resulting from globalization, inherently deflationary technological innovations, and demographic drag from aging populations. The proof is in the numbers: Since the mid-1990s when the three forces started to kick in, price inflation remained below, and tended to act as an anchor for, wage inflation, which has been much more sensitive to the business cycle (Fig. 4).
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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