Never assume the markets are wrong
Here’s the FT:
One can look at equities and bond yields and conclude that one of these markets is very wrong.
Of course markets are always wrong in the sense that each day new information comes in and prices move to new levels reflecting that new inflation. Ex ante, however, there is no reason to assume that the stock and bond markets cannot both be correct. Here’s what I see as the most likely explanation:
1. Long run changes in saving and investment are gradually producing a lower “new normal” of global real interest rates. For any given flow of corporate earnings, that’s bullish for stock prices.
2. Over the past year, expectations regarding economic growth in the US and elsewhere have fallen somewhat. These slower growth expectations have reduced the expected future flow of corporate earnings.
Both factors tend to depress bond yields, whereas factor #1 boosts equity prices while factor #2 depresses equity prices. Taking everything into account, you’d expect bond yields to be much lower than 9 months ago, and you’d expect relatively little change in equity prices. And that’s exactly what has happened.
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22. June 2019 at 08:09
1. Long run changes in saving and investment are gradually producing a lower “new normal” of global real interest rates. —Scott Sumner
If major global central banks were chronically a little too tight, this result would also manifest. Lower interest rates, sluggish growth, and a so-so stock market as bonds would not offer much of an option.
22. June 2019 at 09:05
Ben, Not over 35 years.
22. June 2019 at 09:49
1. I think what Sumner means is that high levels of inequality produce high level of savings which generate rising asset prices but low yields.
22. June 2019 at 11:53
Rayward, That’s possible, but no, that’s not what I mean.
22. June 2019 at 11:57
in personal terms, does that mean that because, for example, interest rates are so low, less people are saving or investing in anything like savings where the returns are poor, instead they tend to buy assets, stuff, property, stocks and shares, etc? Would this mean that the tax that government can get from savings interest rates are going missing? Does all this have an impact on predicting economy for a country? In this country there may be cash rich but income poor individuals looking for a home and return.
22. June 2019 at 12:45
What about the Fed’s amazing track record for outguessing the markets on inflation? (Just kidding)
22. June 2019 at 15:38
Ben, Not over 35 years.—Scott Sumner
What happens in year 36?
For sake of argument, let us say the Federal Reserve began its inclination to tightness with Paul Volcker in 1980. So, we are 39 years into an era of chronically tight Federal Reserve policies.
Now what?
22. June 2019 at 19:40
Ben, Just stop, you aren’t making any sense.
24. June 2019 at 05:17
Good post. On #1, long-term corporate bond yields fell 13% in 1983 to about 4.25% at the end of 2011. For the past eight years, they have moved in a range between 3.50% and 4.75%. The new normal has been with us for eight years now.
24. June 2019 at 12:01
Brian, I agree. The recent fluctuations are similar to what has been happening since 2009.