In our 2015 outlook titled “We’re Just Getting Started,” I pronounced that the current business cycle will ultimately prove to be the longest on record. Muted global growth paradoxically extends the cycle rather than curtails it as ongoing global deleveraging and rising savings rates press central banks worldwide to continue with unprecedented monetary policy accommodation, keeping rates low for the long term.
Investors, mistaking the current environment for a normal cycle, continue to be too preoccupied with looming rate hikes when instead the real story has always been, and will continue to be, sluggish global growth. Alas, in a deleveraging world there can be no decoupling of stronger economies from weaker ones. The formerly prevailing consensus view calling for the U.S. to be the world’s economic and market outperformer is being tested. Global flows and flexible currencies have proven to be the great equalizers.
As the European Central Bank’s (ECB) quantitative easing program gets going and expectations of a rate hike by the Federal Reserve (Fed) later in 2015 get built into the U.S. outlook, the dollar has strengthened against almost every other currency. Already the stronger dollar is transferring some demand from the United States to other parts of the world as foreign exporters become increasingly more competitive. Leading economic indicators in Europe, Japan and emerging markets have all recently shown improvement and international markets are rightfully following suit.
While the past year’s 25% surge in the dollar1 and the trade’s unanimous popularity make me wary of over-extrapolating it, the sheer size of this move means it must be accounted for even if the dollar rally moderates. History suggests that a strong dollar helps the U.S. economy as increased consumer demand offsets export weakness. This time is different. With credit growth relatively subdued and with wage growth climbing at a still-anemic 2%, the offset to weaker exports will be less than in the past.
A rising greenback thus represents an underappreciated risk to U.S. economic growth. Importantly, this does not change my view that the current cycle will ultimately be the longest on record. In fact, it only reinforces it. The coming rate hike by the Fed (yes, it’s coming, much to the consternation of this dove) will likely be the last one for a while. The U.S. economy is simply not strong enough to support or warrant aggressive tightening.
Investors will continue to live in a world where more than half of all government-issued bonds yield less than 1% and nearly 80% of the world’s market capitalization will be supported by near-zero interest rate policies2 well into the future. Being bearish in this environment will not be a fruitful exercise. The case for stocks to outperform bonds and credit to best treasuries is nearly as compelling as it has been for much of the past six years; and in a world where growth and income are scarce, investors will pay up for them. Importantly, unlike in 2014, the U.S. equity market will not be the only game in town.
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