The synchronized global expansion has extended its impressive growth run. What are some of the signs that suggest this positive trend can continue?
You're absolutely right. The growth trend is quite impressive.
We seem to be transitioning away or maybe we've fully transitioned away from the drag of the financial crisis. Now it has been a decade that we've worked through to get here, but I think going forward 2018-2019 are going to have some of the strongest GDP growth rates around the world that we've seen since the crisis. Along with that will be somewhat levels of inflation. We have a variety of leading indicators that we can point to not just in the United States, but also in Europe and in Asia, and these are all at cycle highs and some of them are at all-time highs. They're fuelled by strong levels of confidence, low interest rates, and I think the next couple of years are going to be pretty good years for the global economy.
What key risks to your positive global growth outlook should be top of mind?
Well, first of all, this is a maturing business cycle and with that, you have to think you have a maturing market cycle. I mean, we are decades since the last recession, and it was very very deep, that will tend to mean you have a long expansion following it, but there is a clock on everything, of course. The early signs of this maturing business cycle, you know, the interest rates are now rising, it's appropriate for that, but whenever rates are rising, not falling, there's this increased chance of disruption in markets, shocks, maybe mistakes, we have to watch that. Protectionism, very big in the news now. Never a good thing for planners, for businesses and for investors. And that's certainly something that has to be monitored.
European populism, again, back in the news with the Italian elections over the last few days, always concerns over North Korea. Changes in the leadership model in China and Russia, perhaps not advantageous for global growth and just plain getting along. Against that though, and we always have concerns that we can list, against that, you do have this very strong growth cycle that continues; you have moderate levels of inflation, and completely acceptable and appropriate levels of interest rates. High levels of confidence. On balance, we like the outlook.
Are you concerned by the recent pickup in inflation?
Well, we're monitoring inflation very very carefully. If something could upset this outlook, I think this is the most likely of them. We've had slightly above consensus forecast for inflation for quite some time now, but completely acceptable levels of inflation nonetheless, and really, preferable the inflation would be raising than falling and the fear of deflation now I think is well behind. I think the correction that we saw in January though is reflective of what inflation can do to investor confidence, right? It shortens investors timespans, it brings down price-earnings ratios, it means the same level of earnings is less to investors at a higher level of inflation than at a lower level. And we are coming off ten years of extraordinary monetary ease. In our forecast, as I said, we think this is a normalizing or moderation of two low levels of inflation, but needs to be monitored.
Other than inflation, what other forces have been pushing bond yields higher? How does this affect your outlook for fixed-income markets?
Oh, I think the movement higher in bond yields over the last year really hasn't been about inflation. We think that the bond market has correctly read inflation and priced it in for quite some time. It's the other aspect of the nominal yield, what economists call the real rate of interest. Essentially what that is, is the after-inflation payment for saving versus spending. During the financial crisis, in order to bolster growth, central banks pushed the real rate into negative territory. The United States was below minus a half of one percent. Over the last 50 or 100 years, a very very long term, that payment, the real rate of interest, has averaged about two and a half percent. Now it's about three quarters of one percent right now. It would be natural, as the drag of the financial crisis falls away, and we get to a normal level of growth and we stop fearing the future, that that real rate of interest will move towards two and a half percent, it always has in the past.
Very simple, if you distributed the distance between where you are today, it's three quarters of one percent, and you say five years from now, I'm then 15 years out from financial crisis, I've fully forgotten about it, I need a two and a half percent real rate of interest, well, that's almost a half a percent a year that interest rates ten-year bond yields have to rise. And that's not a bad forecast. So, what it means is, is that bond yields will gradually grind higher over the next several years and we're comfortable with that. The near-term need for a big adjustment I don't think is there, but the path will be higher. And it means you are likely to earn your coupon on a Sovereign Bond over the next half decade.
Has the recent increase in stock-market volatility altered your view on equities?
I think the best reason for a recent increase in stock-market volatility was that they're at all-time low levels and they have been there for a very very long period of time, so, mean reversion is a very strong force in this business and that's what happened. I think more importantly, you get used to it. The stock-market valuations are at an appropriate but very high level, they're fuelled by confidence, and as a business cycle and a stock-market cycle ages, volatility tends to go up. And by the way, returns tend to go down. So, it is a bit of a new environment that we've moved into after ten years of very very strong gains with mostly low volatility.
What will extend the stock market's momentum in 2018?
Well, it's not valuations. You know, people have been concerned about valuations, some people for many years. Well, we've explained them by low levels of inflation in the interest rates. Even though those are starting to rise, they still are at historically quite low levels and supportive of quite high P/Es, relative to what we've grown used to. However, getting further gains out of higher valuations, I think is unlikely. So, you know, you know the way to make money out of the stock-market is that earnings rise, and fortunately they are and we expect them to continue to rise, if not accelerate into 2018-2019. So, we have a stronger economy, we have a bit better pricing power to our inflation. We have a fiscal plan fanning the economy and we have a tax plan, which is immediately bolstering earnings estimates.
You know they're up double-digit in 2017 in the United States, they could be up 15 to 20% in 2018 and earnings again could rise in double-digits in 2019. So, that should keep investors happy and interested in buying equities. I think that the real threat here is that when you have a high level of valuations, you're typically supported by high levels of confidence. And that's much more difficult to predict. Should there be a hit to confidence from whatever source, the same level of earnings could be valued at very different P/E ratios.
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Publication date: March 2018