Running to the Safety of Stocks

In the era after the Financial Crisis, pundits, investment commentators, and the media falsely maintained a constant proclamation that interest rates were just about to rise and that the collapse of the bond market was imminent. When the Federal Reserve Bank (Fed) first lowered interest rates to 0%, the pundits proclaimed irresponsibility and that inflation would skyrocket. Then came Quantitative Easing I & II, and the claim that this equates to the printing of money, which surely had to lead to inflation, irresponsible debt, and rising interest rates. And there is the ever-present adage that interest rates are just too low and that they simply have to “normalize”. The Fed has even stepped in and raised the fed funds rate three times, only to see the yield curve flatten and to witness longer-dated interest rates remain relatively unchanged. Now, with the election of President Trump, the debate has switched from monetary policy to fiscal stimulus. This time the thought pattern is that fiscal spending and tax cuts, which simply amount to massive government borrowing, will lead to rising growth, inflation and interest rates. All the while, interest rates have remained peculiarly low, inflation has tended towards deflation, and we have experienced the worst economic recovery in modern history according to real Gross Domestic Product (GDP). What is it about this post-2008 economic environment that is so different from the prior 50 years of the U.S. economy and traditional economic theory?

Given that we now have 6 months under our belt to digest the expected policies of the Trump administration, a simple check of interest rates shows little material change relative to the post-2008 environment.

While some might think that these yields paid on high-quality bonds are too low, a simple comparison relative to other first world nations’ bond yields reveals that U.S. interest rates are actually relatively high. Could it be interpreted that some of the expected growth in inflation and debt are already considered in current yields? U.S. interest rates are even higher than those in Italy and Spain, which are, it can certainly be argued, lower credit quality countries.

Real GDP growth, too, has remained relatively constant in the post-2008 environment, and after 8 years, it still represents the worst economic recovery in modern U.S. history.

It seems that even though the Fed has maintained near zero percent interest rate levels and the debt levels have been greatly elevated, this leverage has not lead to elevated levels of growth or inflation. All that the leverage has managed to achieve is maintaining the current low level of economic growth against a backdrop of constant deflationary pressure.

While the economy is showing signs of recent reflation – a little more growth, a tick up in inflation, and improved earnings – it is those pesky dark clouds on the horizon that are keeping many investors from being too optimistic about the long-term. The looming problems with population, debt, and globalization continue to warn of deflationary pressure.