A few comments on the end of secular stagnation

The failure of Japan’s grand monetary policy experiment to meet expectations is a warning sign we all should heed. But right now fears of so-called secular stagnation have receded as the global economy has roared back to life. We should not dismiss the threat of secular stagnation so easily. Here’s why.

According to economist Gavyn Davies at the FT, “this recovery in real activity has not yet led to any rebound in long run underlying growth, according to the models. There has been no improvement in the growth of the labour force, and little rise in labour productivity growth, in the advanced economies in the last year.” Conclusion: the underlying demand-side problems that create the threat of stagnation are still there.

What we are now seeing is an uplift in growth created by cyclical demand increases – meaning there has been enough stimulus globally to revive the economy, if only for a while. The question is what happens after that ‘while’ concludes. And the answer is highly dependent on labour force growth, labour productivity growth, and wage growth. Put simply, if you don’t have more workers working more efficiently and getting paid more for doing so, over the longer-term you shouldn’t expect the economy to grow very fast.

Right now, equities are on a tear – hitting record highs for the most consecutive days since 1987. As a result, we are seeing multiple expansion for equities – showing people are willing to pay more for each dollar of profit. Ostensibly, the lift in P/E multiples is justified by a return to growth. And based on macro conditions, growth should continue for the medium-term.

Nevertheless, as Gavyn demonstrated, the demand side problems haven’t actually gone away. Not only is productivity growth low, so too is wage growth. Secular stagnation still lurks as a threat. And if the present return to growth is not durable, those P/E multiples will shrink. And they will do so at a time when the economy turns down and profits are shrinking too. Caveat emptor.

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