With Wall Street hitting all-time highs and the US economy certain to set a new record next month, it seems a lifetime since the despondency in financial markets at the end of last year. Fears of recession have been completely refuted, and investors who shared the view expressed here in early January – that markets were just going through a bout of irrational panic – have enjoyed the strongest start to a year since 1998.
The market’s roller-coaster behavior is easy to explain, at least in hindsight. Investors were understandably worried by four risks last year: overly aggressive US monetary tightening; escalation of the US-China trade conflict; soaring oil prices (possibly returning to $100 per barrel or higher); and another euro crisis, precipitated by the unprecedented left-right populist coalition that emerged from Italy’s election. By the end of the year, however, all of these risks had subsided: the Fed executed a dovish U-turn, the US-China trade war moved toward a ceasefire, oil prices fell, and Italy resolved its fiscal clash with the European Commission in a fairly innocuous truce.
With all of these problems receding, the surge in equity prices from January onward was understandable, and even predictable. The question now is whether this rebound will lead to a resumption of the bull market or turn out to be only a temporary bounce.
In my view, the bull market will continue, despite the fact that it has already broken records for longevity. The US economic expansion will also break historic records when it enters its eleventh year in June. The fundamental reason is that the combination of very low inflation and decently strong economic activity that has characterized the world economy since the 2008 financial crisis shows no sign of ending.
This benign outlook may seem at odds with two concepts that have dominated economic commentary since the financial crisis: “secular stagnation” and the “deflationary new normal.” Both have proved misleading and confusing. “Secular stagnation,” at least as a description of global economic activity, is simply wrong. Global growth has averaged 3.7% since the end of the recession in mid-2009, which is actually slightly faster than the 3.6% average in the 30 years to 2008. And there has not been a single year this decade in which global growth fell below 3%.
How could this have happened, given that growth in Europe, the United States, and China has slowed since the crisis? The explanation is simple arithmetic: China and other emerging economies now make up a much larger share of the global economy than in previous decades. Their increasing dominance creates a base effect that outweighs the slowdown in their national growth rates. For example, China’s GDP growth of 6.5% last year, from a base of $14 trillion, contributed twice as much to the increase in global output as in 2007, when its economy grew by 14% from a base of $3.5 trillion.
This calculation is not just a statistical oddity. Robust and steady GDP growth has been reflected in growing global demand for commodities, energy, and real goods and services, which in turn has translated into robust and steadily growing corporate profits. On the other hand, the concept of a deflationary “new normal” is perfectly valid if we focus on inflation instead of economic growth. In OECD economies, average inflation plunged from an average of 6.2% in the 30 years to 2007 to just 1.9% since 2008.