Capital Market Line: Pullbacks Enable Bull Markets To Endure

The global output gap is decidedly midcycle, despite nine years of recovery, having crawled very slowly out of a very deep hole. None of today’s causes of higher volatility – monetary normalization, trade tensions, potential regulatory troubles for certain FAANGs, and the end of selling volatility for carry – threaten the current acceleration of cash flows. While the length of the recovery might look long, cycles die from excess, not old age; just ask Australia, which is in its 26th year of recovery. Inflation around the world continues to converge, emphasizing that global slack is what matters, not isolated bottlenecks like US labor force tightness.

The end of private-sector deleveraging, which has lifted a wet blanket that had held back the global economy, has boosted confidence and has led to rising business investment focused on new disruptive capabilities rather than raw capacity. Another new growth driver is the end of fiscal drag, which has morphed into fiscal thrust composed equally of supply-enhancing corporate tax cuts and demand-inducing consumer tax cuts. Demographic trends should continue to restrain demand-side thrust, but on the supply side, after the long post-crisis winter of corporate underinvestment, a new globally competitive tax rate together with the fear of disruption is pushing US companies to invest into new technologies to boost productivity. This should notch up macro stability and growth for several years before widening the gap between winners and losers, a backdrop that can easily morph into micro instability. As a result, we don’t see end-of-cycle overheating from the tax cut, but Congress’s new spending itch must be monitored.

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