A quick look at the US and Jamaican economies and stock market (Part 2)Sunday, August 01, 2021
Last week we looked mainly at the issue of global “bubblets” in stock and commodity markets, using research from Morgan Stanley strategist Ruchir Sharma. We looked briefly at Jamaica's stock market boom of 1992, when our market quadrupled, and 2004, when our market doubled.
In 2015, the local stock market doubled again (which I had also predicted at a Mayberry investment seminar at the beginning of that year). However, unlike at least the first and less certainly the second instance of doubling mentioned previously, this was not a bubble. Jamaica's severe economic crisis over the previous few years had left top quality companies at rock bottom values of half book value and around five times earnings. So even after doubling in 2015, stocks were not expensive, and the macroeconomy continued to improve allowing a five-year bull run that only ended due to the COVID-19 shock.
The local market was actually a little “frothy” by the end of 2019, but the macroeconomic outlook of our lowest ever interest rates and balanced budgets had still remained strong, suggesting 2020 would have been another positive year without that shock. Impressively, despite the COVID-19 impact, Jamaica only ran a small fiscal deficit last year and is looking to achieve a balanced budget this year, which, if achieved, would make it almost unique in the world. In such a scenario, we should see a good second half for the local stock market (the increase in business and consumer confidence revealed last week by the Jamaica Chamber of Commerce survey supports this view), which should allow our local main market to exceed its first half gain of 7.5 per cent , and, depending on factors such as the true outlook for US inflation, allow it to outperform the US for the first time since COVID-19. All this, of course, assumes tourism continues its recent strong recovery.
With these caveats in mind, let us look first at US inflation. On Friday morning, Bloomberg had a very revealing interview with Mohammed El Erian, formerly chief economist for Allianz and Pimco, one of the world's largest insurers and fund management groups, respectively (Allianz owns most of Pimco), which collectively manage several trillions US dollars in assets. Now based at Queens' College, Cambridge, which I used to walk past every day on my way to the economics faculty, El Erian still appears to have his finger on global markets despite his new academic setting.
He argues that Federal Reserve Chairman Jay Powell, at his post-federal open market committee meeting press interview, revealed an inconsistency between the Fed's backward looking macro model and Powell's “conviction call” that the current rise in inflation would be “transitory”, meaning it would subside sometime over the next few quarters.
El Erian argues that the Fed's implicit assumption is that the current price level adjustment won't shape the inflation process, so that the current rise in prices — in areas such as computer chips, cars, travel and leisure generally — will be confined to a few items, reflecting mainly supply disruptions brought on by COVID-19, and will work themselves out once supply and demand become better balanced.
El Erian observes that those, like himself, who had lived through the 1974 oil shock, may have a different view. Due to the usual lags, it is important to keep a close eye on the inflation process rather than prematurely dismiss the likelihood of more sustained inflation. He notes that he is not arguing for a return to the inflation rates of the 1970s and 1980s, but that it may double the one to two per cent that the financial markets are currently “wired for”, in the range of three to five per cent, which could have an impact on both financial assets and real world economic activity.
He cites the large disconnect between the Fed's current view, based on its macro models, and the micro views of the major company chief executives he talks to, who are concerned about rising input costs, wages and transportation, which is all happening at the same time. In short, he believes that the Fed should take its foot off the accelerator (gradually reducing its current very accommodating monetary policy) so it doesn't have to “slam on the brakes” in the future.
It is, of course, not new for awkward facts to contradict academic models. In the run up to the global financial crisis at the end of 2007, writing for another newspaper under the column “Vantage Point”, I repeatedly warned that a financial crisis looked very likely. Frankly, this should have been obvious to many (rather than just a few), but judgement was clouded by the predominant view that markets (such as the mortgage market) would always be self correcting, despite much evidence to the contrary. In short, the entirely human tendency to want to process everything as a story, which has now also seeped into politics worldwide. In our next column, we will explore what this may mean for Jamaica's economy, and particularly our policy of inflation targeting.
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