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September 17, 1999 5:18 pm ET
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MARKET ANALYSIS
Sep 17 1999 4:50PM ET More on Economic Focus...
World Markets Mostly Coming up Roses
by Lawrence Kudlow
Chief Economist
CNBC.com
Tour the global markets, says CNBC.com chief economist Lawrence Kudlow, and you'll see improving share prices and no inflation just about everywhere you look.
Let's take a walk around the world. Here's what you see: gold prices are falling and stock prices are rising. Sure, there are a few exceptions, but weak gold and rising shares are the global themes -- just about everywhere.
To me, these market developments forecast more inflation-free economic growth around the world. I call it a worldwide growth trade. Some countries are growing faster, some slower. But growth is the theme. As for inflation, there is none.
Market prices are better forecasters than econometric models. Modelers keep worrying about Phillips curves, output gaps, NAIRUs, asset bubbles, oil shocks, money supplies, wage rates, productivity trends and various other issues that I'm sure all have some significance somewhere. But the market message is more important: rising shares and falling gold signal inflation-less prosperity for the future.
Let's look at some numbers, first on stock markets. Year-to-date, the U.S. Dow is up 20 percent and the Nasdaq is up 32 percent. The DJ Stoxx Index in Europe is up about 14 percent, with France up 20 percent, Germany 9 percent, Netherlands up 10 percent, Sweden up 21 percent.
So far this year Japan has increased about 28 percent, with Hong Kong up 38 percent, Singapore up 53 percent, South Korea up 71 percent, Taiwan up 27 percent, New Zealand and Australia are both up roughly 6 percent. (All these quotes are in local currency terms.)
Coupled with these stock market rallies, gold keeps losing ground. Dollar-denominated gold has lost 12 percent this year, while euro gold has dropped 21 percent and yen gold 22 percent. Arguably, monetary policies in Japan and Europe are too tight; more high-powered liquidity should be injected into both zones.
But the non-inflation trends are unmistakable. Over the past 12 months the consumer price index in Japan has dropped 0.1 percent, while the European CPI is up only 1.1 percent. Wholesale prices in Europe are flat over the past year.
In the United States, meanwhile, growth in the core Producer Price Index has eased from 3.5 percent last January to zero currently, measured as a six month, annualized growth rate. Meanwhile, the core CPI has slipped down from 3 percent in May 1998 to zero currently.
Conventional economists love to hate gold. They blame central bank gold sales for the drop in the precious metal's price, or they argue that gold is irrelevant because no one wants to invest in it. Well, gold remains an accurate indicator of monetary value. In recent years it has also held its usefulness as a leading indicator of no inflation.
The real message here is that leading central banks around the world have restored the purchasing power of money. The 1970s are over. Totally over. Not only have G-7 and other government banks kept money relatively scarce, the Internet economy and new technology investment are exerting downward price pressures everywhere. Think of it as less money chasing more goods. That's why gold is a poor investment. There's no inflation to hedge against.
Sandwiched in between the global rise in stock prices and the worldwide weakness in gold is a surprising increase in long-term bond rates. In the United States, 10-year Treasury yields have moved up to nearly 6 percent today from 4.5 percent a year ago. In Germany, 10-year bunds have shifted to nearly 5 percent from 3.5 percent. For Japan, JGBs have moved to about 2 percent from less than 1 percent.
A lot of observers have looked at the increase in bond yields and concluded that inflation is just around the corner. Instead, I believe the rise in bond rates merely reflects a return to economic normalcy.
That is, a year ago many expected global recession in response to the financial crises in Asia, Russia, Long-Term Capital and Brazil. So real economic growth expectations collapsed, pulling down real interest rates. Investors bought bonds and sold stocks. It was a deflation trade.
But things turned out a lot better. The Fed pumped in liquidity and the world survived.
Growth is still too slow in Europe and Japan, where gross domestic product is rising only slightly more than 1 percent annually. But stock markets there are predicting faster growth in the future. And while a huge overhang of excess capacity remains in Asia, at least growth rates are picking up. Their stock market predicts more of same.
The United States never really stopped growing at all. Actually, temporary deflation improved consumer buying power, while the technology revolution continued to spur investment. Once again, the bears were proven wrong.
But the key point in all of this is that this year's global interest rate rise reflects an increase in real bond yields, not a hike in future inflation expectations. In other words, global expectations of deflation and recession have given way to a new outlook of inflation-less growth. The deflation trade has been replaced by the growth trade.
So real interest rates, which dropped a year ago in expectation of collapsing real economic and investment returns, have recovered this year in response to more optimistic economic growth expectations. That is all that has happened. A return to normalcy.
It is possible that Fed snugging actions are responsible for higher long rates in the United States. Certainly I have disagreed with the Fed attack on economic growth and stock market increases. The Phillips curve relapse is unnecessary. A Fed-free bond market would probably put Treasury yields closer to 5 percent than 6 percent.
But it is interesting to note that long-term rates in Europe and Japan also rose about the same as in the United States, about a percentage point or so, without central bank credit-tightening actions. So something is going on besides U.S. Fed policy. I think it has to do with the growth message of rising real interest rates.
It's a global phenomenon, and a healthy one at that. We are in one of those periods where higher real interest rates coincide with higher stock prices. It proves a theoretical point. Namely, higher real returns on investment and economic growth are bullish for stocks, even while bond prices fall a bit. It's a growth trade.
Over the long run, Wharton professor Jeremy Siegel has taught us that stocks always outperform bonds. This is the ultimate growth trade history. The only time bonds do better is during periods of continuous deflation. Fortunately, these deflationary periods are extremely rare. One reared its head a year ago, but it didn't last long.
The moral of this story is that the world looks pretty good. Not perfect, but still pretty good. There's always stuff to complain about. High tax policies in Germany have (fortunately) spurred an election tax revolt. Japan needs more marginal tax-rate reduction and less monetary deflation.
The United States should send its budget surplus back to the taxpayers who earned it in the first place. Latin America should be completely dollarized. Britain should negotiate a free-trade agreement with the United States and back away from the overly taxed and regulated euro.
China should lower its trade barriers and make peace with Taiwan. Russia should junk all its policies -- and its leaders -- and start all over again. The Middle East should turn its swords into plowshares with a regional free-trade pact. East Timor should be liberated from Indonesia. The New York Yankees should bolster their pitching staff.
But with it all, financial markets are sending a powerful message: rising stocks and falling gold. Inflation-less growth. The Internet economy gone global. Free-market policies are winning. Keynes and Marx are dead.
There's a worldwide growth trade going on. Hold that thought. It's going to last quite some time.
CNBC.com Chief Economist Lawrence Kudlow also serves as chief economist of Schroder & Company, Inc.
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