Hey, look! Goldilocks is back, in the form of an economy that’s running neither too hot nor too cold. Or at least that’s how equity markets seem to be pricing it. Sure, GDP growth is slowing, but the upside of downbeat GDP reads is that inflation is moderate, at worst. And that means central bankers are backing off from their curmudgeonly talk of “normalization” and “gradual rate increases” and all that. Just look at Stephen Poloz, the Bank of Canada governor, who this week — while holding rates steady — said that “monetary policy needs to maintain a degree of accommodation sufficient to offset … various headwinds until the economic outlook improves.”
Yeah, whatever, Steve — you had us at “accommodation.” And it’s all good for stocks. The S&P/TSX composite is hovering near its all-time high, up almost 16 per cent on the year — and it’s only April. The euphoria isn’t just Canadian, either. The S&P 500 is up more than 17 per cent year-to-date; so is the Euro Stoxx 50. Japan’s Nikkei 225 has gained more than 13 per cent. (Yes, Japan, where forecast GDP growth is a hair over 0.7 per cent for 2019…)
And who said the China slowdown was something to worry about? Not me! (Well, not today, anyway.) Chinese GDP growth beat expectations in the first quarter; retail sales and industrial production both grew by more than 8.5 per cent. Not surprisingly, Chinese stocks are well on their way to recovering everything they lost in a terrible 2018, and are now only three per cent down from the start of last year. All of the recovery has occurred in 2019: the Shanghai composite is up nearly 30 per cent YTD.
If these revived investor spirits are a sign of a Goldilocks economy, then that porridge must be some good. And maybe it really is. We’re enjoying (some) growth with low inflation, unemployment is low, and there are few signs of a recession around the corner. Even those market-watchers who judge the business cycle to be in its late stages often point out that the late stages can last for a long time. For investors, riding the wave while it lasts only makes sense, especially when there isn’t a clear end in sight.
And yet, what should be of concern in this environment is the build-up of a kind of moral hazard, which Google helpfully defines as “lack of incentive to guard against risk when one is protected from its consequences.” Because across the board, in all of these recoveries from New York to Shanghai, you can detect the not-so-invisible hand of government backstopping the markets.
Obviously, not all the market rebound comes down to a sense that Big Brother won’t let anything hurt us. Yet I suspect that what western investors really mean when they talk about a Goldilocks economy is that they expect central bankers to keep interest rates at historic lows — and few seem to worry about why the bankers are doing that (sluggish economic growth). U.S. Federal Reserve chair Jerome Powell has been sounding the alarm about the inability of monetary policy to get inflation near target, but it’s all music to the ears of stock investors, who seem blithely unconcerned about the risk of falling into a Japan-style deflationary spiral. Who cares when rates are so low?
Speaking of Japan, the value of stocks and bonds held byitscentral bank is bigger than the country’s GDP. According to research byNikkei Asian Review, the Bank of Japan’s exchange-traded fund holdings comprise almost five per cent of market cap on the first section of the Tokyo Stock Exchange, and by 2020 it could become the biggest shareholder in Tokyo-listed companies. (It’s already effectively the biggest shareholder in 23 of them.)
As for China, I don’t know if the Goldilocks story has any meaning there, but the rebound in stocks has at least something to do with the stimulus package Beijing unveiled in January. That package was relatively small, by Chinese standards, but it showed the willingness of the government to put aside deleveraging an over-leveraged economy in favour of stabilizing the economy. Reportedly, officials are already preparing to announce another round of stimulus. Never mind all thosebad loans.
As welcome as the market recovery in 2019 has been, investors might want to consider at what point optimism ends and wishful thinking begins. There are dangers. One is the potential for a black-swan event to build in an accommodative monetary and fiscal environment. (By definition, no one knows where such an event will come from, but for reference, see U.S. housing crisis.) Another is that if the worst occurs, monetary and fiscal policymakers will be less equipped to support economies — and markets.
So if it’s fairy tales you like, maybeGoldilocks and the Three Bearsisn’t the right one. It might turn out that future economic historians will look back at this period and talk instead aboutThe Three Little Pigs— especially the first one, who built his house out of straw.
What will happen when the wolf comes a-knocking?