With global equity markets continuing to rise, more and more investors are starting to fret that the party might be about to end sometime soon. As the saying goes, however, equity prices tend to climb a “wall of worry” – as long as there’s at least a vocal minority worrying about the market, chances are that prices will keep moving higher.
It’s only when everyone is convinced that stocks are a sure bet will it be time to worry. We’ll see this, for example, when more retail investor money in the United States pours into the equity market. So far at least, investors still remain fairly cautious – perhaps still scared by the global financial crisis, and also reflective of ageing baby boomers seeking relatively greater investment security.
While there are no doubt risks – such as the slowing Chinese economy and still subdued global business investment more broadly – my own view is that global equity markets can continue to trend higher for some time. And my reasoning is fairly simple, suggesting investors should keep an eye on the big picture.
The reason? Stubbornly low global inflation, which has caused many central banks to keep policy settings highly stimulative, even at the risk of potentially creating asset bubbles. While the Reserve Bank of Australia likes to keep a close watch over financial stability, other central banks remain far less cautious. Rightly or wrongly, the US Federal Reserve, the Bank of Japan and the European Central Bank see stubbornly low inflation as a massive economic threat and will keep policy settings easy until this threat goes away.
But I don’t see this threat disappearing anytime soon – especially in economies such as Europe and Japan where populations are ageing and productivity growth continues to add to the supply of goods and services. Yet unlike these central banks I’m much less fearful that low inflation – even deflation – will cause economic growth or corporate profits (at least in real terms) to stumble.
Deflation caused by positive supply shocks – such as intensifying global competition and productivity improvements – need not be bad for the global economy. Indeed, prior to the onset of rising inflation during the 1960s, the global economy managed to cope quite well with periods of stable or even falling prices.
Under this scenario, the inability of central bankers to slay the phantom deflation dragon will keep monetary conditions easy – and probably easier than they should be. In turn, this will keep the “search for yield” across global markets alive and well.
Of course, I don’t pretend that the current market upswing won’t end it tears. It probably will. But perhaps it will take a recreation of bubble like equity market conditions – and the swelling consensus behind stocks that I talked about earlier – before we reach this danger zone. I would not be surprised to see a new stock market bubble develop over the next one to three years – especially, once again, among US technology stocks. Investors should enjoy the ride while they can, but stay alert to signs of extreme overvaluation and market euphoria.
