Chris Johns: Is this a stock market bubble or economic growth?

Led by the US, stock markets have been buoyant since Donald Trump’s election. In some cases it might be more accurate to say that stocks have been booming: in any event, there are plenty of warnings that the latest rally has taken us to “bubble” territory.

Nobel prize-winning economist, Robert Shiller is famous for a measure of US equity valuations: his calculation of today's level has only been matched twice before in nearly 150 years of stock market history. One was just before the 1929 market crash, the other just before the bursting of the dot.com bubble at the turn of the century. Stocks subsequently crashed by about 80 per cent after 1929 and by 50 per cent between 2000 and 2002.

Only two data points

Two, and only two, historical data points don’t add up to a compelling statistical case for what might happen next. But they allow for lurid headlines and lend an air of plausibility to those who claim to know where the the markets are going. The simple but brutal truth is that nobody has any idea what stock markets will do this year or next. None whatsoever: stock prices over the next few years will forever remain one of life’s known unknowns. Robots may take over all of our jobs but the role of the stock market forecaster will never be replaced by artificial intelligence since no intelligence of any kind is ever needed; indeed, it is always a hindrance to confident sounding prognostications.

But we can make some general statements, heavily conditioned on the future looking something like the past. It is eminently sensible to assume that equities, particularly of the US kind, will, from today’s elevated levels, deliver future returns significantly below what we have become used to. And that’s about it: pension funds and other savers should take note.

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Trump rally

The correlation between Trump’s election victory and rising stock prices is generally assumed to imply causation. The “Trump rally” has been driven, apparently, by expectations of deregulation, tax cuts and massive infrastructure spending. More generally, Trump has been credited with a rekindling of US corporate “animal spirits” that will in turn lead to a booming economy and rapidly growing profits. All of this might be perfectly true. In some cases it is perfectly rational: shareholders in Goldman Sachs and other banks have already been (further) enriched by the prospect of lower capital requirements. That’s capital that will be handed straight back to shareholders should the necessary regulations be relaxed. And so on. The point is that not much has actually happened yet. All of these celebrated policy shifts still lie in an uncertain future.

An equally plausible explanation for the stock market rally is that the world economy has suddenly and unexpectedly resumed vigorous growth. That doesn’t rule out a Trump effect – economic growth and Trumpism are not, for the moment at least, mutually exclusive.

Over the past four or five months or so the economic news flow has been truly remarkable. From just about everywhere in the world, things have been getting better. If it wasn’t for Trump and Brexit we would have seen many more headlines about surprising and robust growth. Attention, of course, has been focused elsewhere. To the extent that we have been looking at growth at all it has been to marvel at the way in which the UK economy has held up, defying all those gloomy forecasts. It’s beginning to look like the British economy has simply been participating in a sudden global upswing.

Stagnation

For much of last year we were assailed with warnings of "secular stagnation". Surplus savings, lack of investment opportunities, demography, the end of technological innovation, central bank impotence: all of these were trotted out to explain why economic growth will remain feeble forever. To be fair, all of these ideas are plausible and are, in fact, reasons to be concerned about the future. Inevitably, however, just as pretty much everyone bought into the notion that the world economy was destined for semi-permanent stagnation, growth suddenly and magically reappeared. That, as much as Donald Trump, lies behind the stock market rally.

Of course, if growth can mysteriously resume it can disappear in a heartbeat. But the consistency of the data, the fact that it is happening pretty much everywhere are reasons for cautious optimism. If so, Donald Trump and Theresa May may turn out to be the luckiest charlatans in recent history: economic growth cures a lot of ills.

Inflation

The dark side of growth is inflation. No sane person would be remotely concerned by a resurgence of price pressures over the next few years: it’s unlikely but even if it happened it should be welcomed. But we are already seeing stories about German inflation worries leading to pressure on the ECB to think about ending monetary easing. That’s code for higher interest rates. While plainly bonkers, expect more of this if the growth renaissance continues.

Just when we least expected it, the world economy has started to grow again. Given all of the things that we are supposed to be worrying about, that’s a welcome surprise. Long may it last.