What are the risks in 2018?
We have been optimistic about markets since private-sector deleveraging ended and growth and cash flows accelerated. Those factors, plus the lingering global savings glut, a consequence of deleveraging, and the resultant low interest rates, which have lagged rising cash flows, all explain why equities have gone straight up. While the positives continue, we nonetheless should reflect on what could go wrong in the new year.
A flattening yield curve historically has been a reliable forecasting tool. Today’s flattish yield curve is flashing a cautionary yellow light. In 2006, when the shape was much like today’s, the yield curve foreshadowed the crisis that began in July 2007. But that was the yield curve’s finest hour as a forecaster. During a prior flattening in the mid-1990s, the economy and markets roared ahead for another five years before trouble began. In the past, economies and stock markets normally accelerated for 12 months after reaching the current degree of flatness.
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