The more I think about the future the greater my uncertainty becomes. Two years ago I was expecting a global melt up in stocks as the global economy recovered, but as the recovery became more and more wishful thinking, I gave up too soon last year. The 2017 stock rally has convinced many that now is the time, but we now have the bulk of wealth controlled by baby boomers that are unlikely to abandon the safety of bonds, while the impetuous youthful generation is now pursuing the astronomical promise of wealth offered by crypto currencies.
The greatest change in global financial markets has been the acceptance of quantitative easing, or central bank purchase of bonds to artificially suppress interest rates. Japan was the first major developed country to implement QE in the 1990’s, and although their stock market never returned to 1989 highs and their economic growth never returned either. There has been no previous attempt to reverse QE, and both the US and Europe plan on doing so over the next few years. The effects that the reversal of QE has will be the greatest source of uncertainty, barring war, for the next ten years or more.
My personal feeling is that QE has not only suppressed interest rates, but has also suppressed the risk appetite of corporations for investing in the economy, replacing the building of factories and the hiring of more workers with stock buybacks. It is likely then that the reversal of QE will decrease the demand for financialization and increase first growth and then inflation.
How this plays out in financial markets is the real question. If growth increases faster than interest rates, then a melt up in stock markets becomes more likely. However, if interest rates increase faster then a moderate bear market is more likely. Demographics seem to favor a slower increase in rates, since retirees are unlikely to throw their life savings into stocks given the volatility of the past twenty years.
My personal bias is a moderate bear market over the next two to three years, similar to the 1970-72 bear market with a longer term similarity to the 1970s. I seriously doubt that more than a 50% correction is seen from the highs that could still go 10% higher, and the larger correction may be 5 to 7 years away. The housing crisis and bust was relatively easy to spot and was mainly due to policy errors with a president that fired his economic advisor after warning of a possible housing crisis, a Fed head that insisted the risk was minimal, and the exit of Buffet from the market in 2006. It is doubtful that central banks will not be more watchful for the next few years.