July 21, 2017
Complacency reigns. Implied volatility of both equities and bonds are at new lows. Financial markets are clearly unconcerned regarding the potential for a meaningful shift in economic fortunes. The markets seem to be predicting continued modest economic growth, low inflation and benign central banks that will remain supportive of markets. The 5-year real yield on TIPS (Treasure Inflation Protected Securities) is only at 0.15%, indicating the market does not expect a significant pick up in either growth or inflation over investors’ typical investment horizon. Additionally, there is almost $12 trillion in bank savings deposits earning meager interest which suggests many people are reticent to take market risk. There are plenty of short-term risks to be concerned with from geopolitical risks to a major policy mistake. A systemic concern is the crushing debt burdens in many regions and markets that will potentially impact long-term growth prospects. On the other hand, financial markets are not pricing in the potential for a fundamental shift in tax policy that could adjust the trajectory of the domestic economy and earnings. We are hopeful, but not optimistic, that the Trump administration and Congress can get something done before the congressional election cycle begins.
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