Business cycles usually end with either a policy mistake or excesses in the economic system. The possibility of a policy mistake is lower now than it was in 2018. Last year, fiscal stimulus drove U.S. growth to the highest level seen in years, and that raised expectations of additional monetary tightening by the U.S. Federal Reserve (Fed). The U.S. economy, following a brief spurt of above-trend growth, is now slowing back toward its trend rate. Appropriately, the Fed is backing down from its tightening stance. I expect the European Central Bank will follow the Fed’s cue.
On the flipside, China is putting forth stimulus-lite measures to stabilize its growth. To be fair, the prospect of a deepening trade war between the U.S. and China still looms, but it will be more difficult for the Trump administration to fight a trade war with 2.5% growth than it was at 3.5%. For equity and credit markets, the mix of slower U.S. growth and better policy is preferable to strong U.S. growth and bad policy. I expect market returns for 2019 to be significantly better than those of 2018.
We also think the concerns over growing excesses in the system are generally misplaced, and in most instances border on hyperbole. For example, credit growth tends to be a good indicator of the health and sustainability of the business cycle. Currently, credit growth is running at a rate that is only about a third of the “danger zone” rate that has historically presaged recessions.
Corporate balance sheets, including those of the nation’s banks, look as good as they have in years. Households have spent much of the past decade paying down their debt. The fiscal balances of most emerging economies are strong, with a few notable exceptions such as Turkey. All of this, in a backdrop where U.S. stocks are cheap, relative to U.S. Treasuries at levels not seen since early 2016 and, before that, in 2013. International and emerging market equities are also as inexpensive, relative to U.S. equities, as they have been in years.
In summary, all the usual indicators of the end of a cycle are not present, and we do not believe they will be for another five years and maybe even longer.
Read the full paper, Five More Years.
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