Sir, While Mohamed El-Erian argues that low commodity prices and bond yields demonstrate that the risk to stocks is a faltering economy, I feel the risk to the US stock market is a stronger economy (“ Equity investors should heed the message from commodities and bonds”, Insight, December 2).
Thus far in the recovery from the global financial crisis, US stocks have existed in a benign “Goldilocks” economy where growth has been strong enough to increase revenues yet weak enough to suppress the input costs of labour, raw materials and interest rates.
A stronger economy would destabilise this equilibrium by increasing costs, particularly interest rates, which in addition to affecting profits directly, affect valuation through the discount rate of future earnings. The higher rates go, the less valuable are future earnings in today’s dollars.
Regarding negative risks to the US economy, we can discount the possibility of a domestically driven (as opposed to geopolitical) slowdown in the US economy from the standpoint that such outcomes are typically the result of overheated markets, whether they be labour, credit/real estate, commodities, or stocks. I think it is a stretch to claim that there exist such excesses currently. Even with US stocks trading at the upper band of their historical valuations, they are far from extremes. Furthermore, as US exports are a relatively small component of gross domestic product, global weakness in itself will not be able to cripple the US economy.
While a stronger US economy is far from certain, it poses the greater risk to US stocks by destabilising the current equilibrium that has proved so potent for share prices over the past five years. On the other hand, traditional indicators of impending economic weakness, such as overheated input and asset prices, are not present.
Chicago, IL, US
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