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Everything is rosy in the economic outlook, so why don’t we feel happier?

In such a good environment, investors are surprisingly gloomy. Is it time for some Christmas jollity?

  • These are happy times for the global economy, with almost every country in the world showing positive economic growth
  • Inflation is benign and wage pressures are yet to re-emerge for companies
  • But is this positive environment all it seems?

In the spirit of Christmas, we should all be a bit cheerier. After all, on the face of it, we are living through some of the most benign economic conditions seen in some years. Just 10 counties are forecast to experience a recession next year, compared to over 100 in 2009. Inflation is benign and volatility is low. What’s not to feel great about?

The ten countries due to experience recession are all small, and all have some kind of idiosyncratic reason for their economic weakness – Venezuela, for example. All the major economies of the world are due to report stronger growth next year, in spite of some major challenges for some (Brexit?).

This has been achieved with no apparent resurgence in inflation. The most recent inflation statistics from the Eurozone show core inflation running at just 0.9%. This is in spite of some pretty impressive growth figures – 2.5% year on year in the third quarter. Globalisation has kept wage inflation lower, which has helped.

Within equity markets, volatility is low. Markets have been gliding higher for several years. While we know in theory that the stock market should be volatile, it certainly doesn’t appear like this in practice.

Maybe we should just enjoy it, this brief moment in history when the stars are aligned and everything is ticking along nicely. The trouble is, it doesn’t quite feel right. We know, for example, that the current volatility figures are - at best - a misleading guide to investor sentiment. There is plenty to worry about – from Trump to Brexit to high valuations.

Inflation is supressed, certainly, but not permanently. Globalisation means that global capacity needs to be used up as well as domestic capacity for wages to rise, but that will happen eventually. Markets, particularly bond markets, continue to underestimate the risk of inflation returning to the system.

The worry is that people start to believe that the past few years represent reality, rather than an anomalous moment in time driven by loose monetary policy. They start to base investment decisions on the current low volatility environment. They will be less and less prepared for the shock when it arrives. Perhaps we are right to worry after all.

 

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