The writer is chairman of Fulcrum Asset Management
When Lawrence Summers identified the central importance of secular stagnation for the global economy in his speech at the IMF in 2013, the Harvard professor put his finger on the most important motivating force for the financial markets in the 2010s.
And it remains so. The direction of secular stagnation after the pandemic passes into history will be crucial for asset prices.
Prof Summers’ interpretation of the term — originally coined by Alvin Hansen in 1938 — argued that excess savings relative to intended investment had driven the global equilibrium real rate of interest well below zero by the mid 2000s, making it difficult for monetary policy to provide the needed stimulus after the 2008 financial crisis.
Actual real interest rates did fall somewhat, but not enough to forestall sluggish growth, so inflation dropped below the 2 per cent central bank targets, notably in Japan and the eurozone.
These forces explained many of the key trends in global markets. Short-term interest rates remained “lower for longer”, not because the central banks tried to inflate an artificial bubble in asset prices but because they responded appropriately to the downward pressure on equilibrium real rates.
Nominal and real bond yields continued to fall in advanced economies, hitting the effective lower bounds in many. As the demand for “safe” fixed income securities exceeded supply, a desperate search for yield spilled into corporate credit and emerging market debt, forcing credit spreads lower.
Equities benefited from the lower discount rate on future profits resulting from lower risk-free interest rates. Share prices defied the sluggish growth in output and rose to dizzying heights. Meanwhile, profits have benefited from low wage inflation, another possible symptom of secular stagnation.
Yale’s Robert Shiller, who had warned of earlier equity and housing bubbles, has recently written that lower bond yields support the high valuations of equities, relative to past and future profits. In his view, there is no obvious equity bubble in the overall market this time.
Equities that gained from technological and structural changes, in particular, the Faangs — Facebook, Apple, Amazon and Google and Netflix — were deemed to have the best long-term revenue growth prospects, so they benefited the most from declining discount rates.
However, recent valuations in these new growth companies, fuelled by speculative phenomena such as the explosion of special purpose acquisition companies, or Spacs, do seem to be extremely frothy and are very vulnerable to any rise in real bond yields.
Even during the pandemic, secular stagnation still played a critical role. Markets had become accustomed to large-scale central bank asset purchases alongside burgeoning US budget deficits under President Donald Trump, without seeing any adverse effects. So they were willing to accept the massive fiscal and…
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