10 years of economic quagmire showing signs of drawing to a close, says Principal Global Investors

Bob Baur

Principal Global Investors’ Chief Global Economist, Bob Baur has called the likely end of the economic quagmire that began with the U.S. financial crisis in mid-2007.

Is the global economy finally in transition?

“In relatively free economies, no cycle lasts forever. The ongoing global cyclical upturn may be the start of a long-term transition to an era of better growth with mild inflation. For several months, we’ve described the cyclical economic rebound from that quagmire: a global upturn that has synchronized around the world became firmly established last summer and was finally accepted by the investment consensus after the U.S. election. That recovery is ongoing, improving, and likely to last well in 2018.”

“What is now happening is likely much more than just a cyclical bounce from an economically ugly time. It’s probable that the adjustment costs of doubling the world’s labor force are behind us, so the global economy is likely in a long transition to an Old Normal.”

Recovery is a production of two ‘acts’

“Cyclical reflation, or a rebound of inflation and growth, has come a long way over the last year. The first act of reflation was the recovery phase. After five years deflation ended: a very big deal. Deflationary pressures from the plunge in commodity prices hit goods-producing sectors hard but once those price-pressures receded, industrial production stopped falling, and business surveys, key measures of activity, rebounded too. Global trade picked up and Chinese exports and imports surged. The finale of Act I was a return to normal confidence levels. Business and consumer confidence estimates reached six-year highs in Europe and U.S. business and consumer confidence indices reached the highs of prior cycles.”

“Starting early last year, the global economy began to rebound from several years of deflation and a near-recession in 2015. As investment and wages pick up in the United States, core inflation improves in Europe and Japan, and growth in China stays the course, this recovery should move to Act II: sustainable, above-trend growth.”

Central banks gradually gain confidence

“The Fed, the ECB, and the BOJ are all feeling better about their respective economies, but the Fed is the only one to normalize policy. The ECB is likely next. The Bank of England (BOE) is standing pat as its policy is tied to exit negotiations from the European Union.”

The synchronized global upturn is alive and well and will likely lead to the beginning of Act II. A sustainable expansion, favorable election results in Europe, and a partial fading of political risk should overcome investors’ tendency to rush to quality at the first whiff of adverse news. Further, if these forces combine with better hard data in the United States and ongoing strong job growth, U.S. yields will move higher.

Asset allocation and timing the next bear market

“Is it time to worry now? No, we don’t think so. While it may be time to at least start thinking about it, April certainly wasn’t the beginning a bear market. Stock markets generally trended higher in April and the year-to-date.”

“Clearly, bear markets are associated with economic recessions and have preceded or coincided with one for decades. Our models and intuition suggest low odds of a U.S. recession this year or even in 2018. Profits are picking up; job growth is excellent; capital spending is increasing; confidence has surged; inventories are lean; the global upturn continues. What’s not to like? Tight monetary conditions often presage economic drags and a bear market. But, with an ultra-cautious Fed, super-accommodative central banks in Europe and Japan, and still very low interest rates, monetary problems seem like a non-starter.”