Several myths have taken hold among market watchers lately. Rick seeks to dispel them.
Several myths have taken hold among market watchers lately. They relate to the state of the economy, the attractiveness of various asset classes and how the Federal Reserve (Fed) should be judged in meeting its policy goals. Dispelling these myths—with the help of economic facts, reliable financial measures and an understanding of big-picture secular dynamics—can help investors better discern the direction of the economy and markets.
Myth #1: The U.S. is suffering through a weak and disappointing recovery that has resulted in a sluggish economy overall.
This myth fails to appreciate much about the character of the current economic cycle, including that after a couple years of meager growth post-crisis, the U.S. labor market has displayed considerable strength in recent years. In fact, according to Bureau of Labor Statistics data as of June 2017, the U.S. has employed roughly 16.4 million people since the beginning of 2010. Furthermore, since 1970, the U.S. economy has only produced an unemployment rate of less than 4.3% about 4% of the time (from March 1999 to February 2001), and we are likely to again find ourselves in that range during the next few months.
This labor market recovery appears all the more impressive when it’s considered in the context of structurally lower economic growth due to population aging trends, as well as the technological disruptions being experienced by many industries. Demographic trends have shifted dramatically in the U.S. over the past half century toward an older population, and hence potential growth has to be structurally lower today, even as we hire great numbers of people (to say nothing of deploying ever greater numbers of robots).
Myth #2: Investors will likely reduce fixed income exposure, as it looks less attractive today and as additional supply is set to push yields higher.
This notion may make sense at a basic level, but it simply misses the massive need for yielding assets in the current investment landscape, and the dearth of available supply. In fact, nearly $200 billion has flowed into fixed income funds year-to-date through the end of May, according to EPFR Global. And this year alone, central banks are likely to buy roughly $1.4 trillion of fixed income assets on only $1.9 trillion in net supply. This dynamic has resulted in a very significant supply/demand imbalance within fixed income markets that is likely to take quite some time to resolve.
Myth #3: Lower levels of unemployment always drive higher wage growth and inflation.
Finally, there has been a widespread misunderstanding about how the Phillips Curve has been operating during this cycle, with excessive faith placed in the historic relationship between lower levels of unemployment driving higher wage growth and inflation. Some evidence from Evercore ISI suggests that U.S. states with the lowest unemployment rates have above-average rates of wage growth, and vice versa. But in the aggregate, the relationship between unemployment and inflation appears less strong now. Broad inflation will likely follow unemployment much more slowly during this cycle than it has historically, and it may well not dramatically overshoot the Fed’s 2% inflation target for a long time.