Nobody has asked me this, so that’s why I am asking myself the question. The initial omens for 2018 are all good: it comes after a year which some people consider as having been exceptional, and it has been in some way. Why won’t that continue?
Let’s see. What happened in 2017 is a kind of miracle. Growth has strengthened across the globe, and the negative geopolitical omens which threatened to toss everything up in the air have not materialised. Let’s say that these geopolitical risks are still alive and kicking, but we’re going to leave them to one side here because they are unpredictable: with the best will in the world, who can guess whether North Korea’s leader will bomb South Korea or the US.
However, I believe the roots of the virtues of 2017 have their own weaknesses. And that’s what I think stops us from saying that 2018 is going to be like 2017.
What are these weaknesses? Some of these I have talked about in my friendly debate with Hugo Ferrer. In summary: for Hugo, the fact the yield curve is inverted is not a reliable indicator that things are going to go wrong. Effectively, in his graphics you can see the curve begins to invert months before the recession arrives. But that’s for a reason: the yield curve begins to flatten out and inverts when the central bank raises short-term rates because inflation has got out of hand. When recession comes, the curve rises once more because the Fed cuts short-term rates again. In other words, the yield curve moves because short-term rates are defined by the Fed, and they go up or down around long-term rates, which are usually more stable. So what I expect in this year which has just begun is that everything depends on the curve continuing to invert. And if the central banks continue gathering up liquidity, reversing their assets due to QE, and raising rates, then the most likely thing is that it will invert further.
But my other reason for not being so confident are the unequivocal signs of an excess of optimism and a low estimation of risk, as I have said before.
In summary, what I am saying is that 2018 has started off giving very clear signs of a euphoria, of “animal spirits”, and I don’t think it’s reasonable. VIX at record low levels, stock markets at record high levels, and all that in a world where debt has also risen to record levels. Take a look at the following graphic:
We can see the growing divergence between the VIX and share prices, and I believe that this is a kite, held on to by a thread, and this thread is not infinite…so, apart from exogenous reasons, I think this is not sustainable for ever. Can 2018 hold up? In economy, it’s impossible to predict the actual moment, but I believe the animal spirits will change sooner or later. And not for exogenous reasons, but because of this variable’s own natural evolution.
And there are reasons to support this: the performance of the real economy, which is not very brilliant. Almost all countries are seeing a decline in the working population, as is notable in Japan:
The only compensation for this is productivity, but this has disappeared off the scene. So it’s no suprise that despite Abenomics’ “success” in growing the economy, it hasn’t been sufficient to reduce the Public Debt/GDP ratio, which is astronomical.