Today’s Rational Exuberance

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.

.. 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.
.. 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.
.. 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.
.. 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.
.. 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
.. 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 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 synchronized than in any previous global expansion.

.. 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 coordinated global expansion.

.. 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 favorable, Europe, Japan, and many emerging markets are now entering the sweet spot of their investment cycles

.. All of these cyclical reasons for optimism are, of course, challenged by long-term structural anxieties.

.. 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.