The volatility of the economy - a problem for stocks

It may happen that instead of inflation, namely the volatility of the economy will be a real test for the stock markets in the coming years.

The consequences of an unprecedented set of circumstances and political action is very foggy outlook for economic growth and inflation. For investors, the stock market, this means much less certainty in the forecasts as profits, and methods of assessment to which they are accustomed to for 25 years before the current crisis.

In fact, not necessarily low interest rates and inflated balance sheets of central banks can cause inflation. This is true, but it is also possible and the Japanese deflationary scenario. There are far more tangible chance of serious shocks of inflation, economic growth and changes in monetary policy than in any other period since the Second World War.

This is the end of the so-called Great Moderation, a design that keeps the economic growth and inflation in the necessary framework. This, to a greater extent, was an illusion, but as long as it existed, investors were willing to pay more for profit companies.

The more stable economic growth, the more predictable is the company's profits. Sustained inflation is also a great boon for investors, it makes it easier to discount future flows of funds, but also leads to a smaller number of painful mistakes of officials. In the end, much easier to go 60 miles per hour on straight, flat road, than that which was littered with sharp turns, sudden ups and downs.

Long-term moderation, as a rule, enhances this effect. Investors are more inclined to diversify the flow of investments for future profits.

In this period is remarkable is not that investors have become more cautious, but how quickly confidence returned to him. Price / earnings ratios in the United States is currently close to 14-15, and resumed growth, while below the last peak, but still well above levels at which it was in 1970 and 1980. Price / earnings ratios fell throughout most of the last decade, driven by the downward bursting Internet bubble more than the disappearance of the illusion of moderation.

Volatility of inflation is much stronger, it is at levels that are not recorded in the 1980's.

"We came to a rare moment when the figures are much higher than their normal levels for such examples of economic instability," - wrote William Hester (William Hester) of the Hussman Funds in the commentary to investors.

This can happen because investors put no more that politicians will try to simultaneously suppress growth and control inflation, and that they will do anything for the previous stimulation of economic growth. Betting Bernarke and against the Depression was the right strategy in 2009, but at the moment the situation is more complicated.

Demographic support the deterioration of the stock market

Bond, Tim (Tim Bond), strategist at Barclays Capital in London, thinks that the moment the stock market valued more or less correct, but assumes that in the coming years it will put pressure combination of factors, including economic instability.

Demography, as Bond says, will help to reduce support for the shares, as the baby-boom generation ages and begins to retire. As soon as the middle-aged people are preparing for retirement, they are likely to hold fewer shares, as at the time of retirement they would have to spend all their savings. This should put pressure on stock prices at least 10 years, unless of course the Chinese and Indian long-term investors will not suddenly developed an interest in the stock market.

I am willing to bet that the motion will be the other way.

It is also true (and understand), why lower levels of global economic growth is necessary in order to reduce inflation in the goods. If such a situation would have continued, it will become a headache for bankers and investors from Beijing to Washington.

In the end, because we have been formally introduced reflation, the biggest risks to price / earnings come from the political mistakes. They are of two types: intentional and unintentional.

For central bankers now much more difficult time because they know the actual situation in the economy. Nobody knows what really happens U.S. interest rates when the Fed will end support: neither you nor I, of course, not the Fed. No one knows when or how the banks will start lending again, accelerating the rate of money in the economy, and with it, and inflation. Fed may be done with good intentions all terribly wrong.

In addition, the unemployment rate is extremely high, and it will take years to make it down to acceptable levels. May continue to handle the huge budget deficit would be correct in these circumstances: politically, economically or morally, but hard to argue that this development would not create temptation for central banks and does not increase the risk of economic instability. 

 

 

Reuters