Investment Strategist Ed Yardeni thinks that the specter of a global trade war is exaggerated and that equities still have more room to run.
Dr. Ed, since February investors have to cope with much more volatility in the financial markets. What happens next in the journey for US stocks?
I remain bullish. I’m expecting that the stock market will continue to move higher along with earnings. So far, I’ve counted 60 panic attacks in this bull market which started in March 2009. Four of those panic attacks were outright corrections of 10% but less than 20%. When the market took a new dive in early February I’ve said that it’s a flash crash and it’s not going to be something terrible. But you always have to keep in mind the possibility that one day we will have a panic attack that will actually turn into a severe bear market. That’s when you want to get out. But right now, I’m still in, since stocks are among the best investments in the long run.
What’s the foundation for your bullish outlook?
We had a significant melt-up in the market in January, largely because of the corporate tax cut. Since then we’ve had a lot of volatility because the good news on earnings was offset by concerns about a possible trade war and the realization that the Federal Reserve would continue to raise rates with the economy performing quite well. So we’ve had a tug of war between the bulls and the bears in February and in March. But as we get further into April, the upcoming earnings season should continue to remind investors that earnings have been greatly lifted by the tax cut. So I’m using a target of 3100 on the S&P 500 (SP500 2658.07 1.72%) by the end of this year and that’s because by that time the market will be looking at higher earnings.
The expectations of a big tax cut have pushed stocks higher for the most part of last year. Aren’t lower taxes already baked in at this level?
Congress passed the Tax Cut and Jobs Act at the end of last year. As a result, the expected growth rate in corporate earnings this year basically doubled from about 10 to almost 20%. It had a dramatic impact on earnings expectations. And of course, beyond that, earnings will grow back at their normal trend pace which is around 7%. During January when we had the corporate reports for the fourth quarter, company managements were very happy in announcing the impact of the tax cut on their earnings. But they didn’t know exactly how much of an impact it would have. In the first quarter announcements coming in April, they will give us specific numbers and I think they could turn out even better than the initial assumptions. So the earnings picture is great but that’s not just because of the tax cut by the way.
What else is fueling earnings growth?
The reality is that the global economy is doing very well. I know there have been some questions recently. But our data still shows that Europe is doing extremely well, Japan is doing better and the Emerging Markets are performing very well. We basically had a global growth recession in late 2014 and 2015 caused by the collapse in energy and other commodity prices. But those prices started to go back up in early 2016. Still, oil prices are much lower than they were in early 2014 when they were over a $100. Now, they’re more like $60 and that turned out to be a stimulus for the global economy. But probably the most significant cause of the revival of the global economic activity is kind of a déjà-vu: It’s similar to what happened in 2008/09 when China provided an enormous amount of stimulus. At that time, we saw a tremendous increase in Chinese bank lending and spending and that helped the global economy. Well, now they’re doing it again.
Also (ALSN 126.4 1.77%), the revival of the European economy took many by surprise. What’s your explanation for the economic springtime on the old continent?
Europe has been stimulated by the ongoing liquidity provided by the ECB. In addition to that, the migration flows from the Middle East and from Africa in 2014/15 might have actually turned out to be pretty stimulative. I know, there are concerns that those immigrants will bring in a lot of social tensions and maybe even some terrorism. But history shows that mass migrations tend to be very stimulative for economies. So that may also be accounting for the strength in Europe.
That sounds quite upbeat. But is there anything investors should keep an eye on in terms of risks?
Inflation really is important. I think it’s dead which is a strong statement and I may turn out to regret it. But if I’m wrong about anything I hate to be wrong about inflation. Because if inflation does come back we will see a completely different environment for investors. Interest rates will go up and bond yields will go up and stock markets will take a dive. But I don’t see that at this point.
Why is inflation so dangerous?
Inflation is actually much more important than recessions in the business cycle. Recessions come and go and when they occur they’re awful and everybody gets very pessimistic. But history shows they don’t last very long. In contrast to that, inflation tends to persist: either it goes up for a long time or it stays low for a long time. My work suggests that inflation tends to be a war time phenomenon and when you have peacetime the result is globalization.
What do war and peace have to do with inflation?
During peace times national markets get more integrated and as a result there is more competition on a global basis. So global competition together with technological innovation and aging demographics is a real inflation killer.
But then again, it sure looks like US President Trump is focusing more on protectionist measures which could push the United State into a trade war with China.
This whole situation reminds me of the concept of the bond vigilantes back in the early eighties. Bond vigilantes are bond market investors around the world who protest monetary or fiscal policies they consider as inflationary by selling bonds. So they sort of act as the law and order in financial markets. As a matter of fact, Bill Clinton when he was President was very cognizant of the bond vigilantes. Today, in a similar way the tariffs President Trump intends to slap on certain imports might be the incipient formation of the Dow Vigilantes.
Read the full article here by Christoph Gisiger, Finanz und Wirtschaft