If it is impossible to know where the world is going, it is at least advisable to try to have a clear idea where it is. To understand the state of the global economy, therefore, it is useful to look at it through the lenses of the most critical factors: growth and interest rates.
Second, the US 10-year bond yield acts as the benchmark for the discount rates used to price all securities. The lower the interest rate, the higher the valuation investors will place on a future income stream. Investing went from being about mitigating risks to being about how to take advantage of any apparent risk and return mispricing arbitrage. Suddenly there was a market for everything, as investors created demand for more and more exotic asset classes in a voracious hunt for returns.But overly easy fiscal and monetary policy during the pandemic, combined with supply-side blockages and soaring energy prices following the invasion of Ukraine, has resulted in the highest inflation since the 1970s.
It remains to be seen, however, where growth will go from here. Much of the low-hanging fruit has been plucked. Globalisation has stalled, if not been in reverse. Skyrocketing energy prices are sapping savings and gross fixed-capital formation, and are likely driving the eurozone and the UK into recession in early 2023.
With employment at all-time highs in the US, UK and Europe and labour markets unprecedentedly tight, unemployment can only go one way: up. Valuations are almost delusional in their optimism and conviction of this outcome. Yearly profit growth of 5.2% is the consensus expectation for the S&P 500, which off the strong base of 2022 seems extremely elevated and entirely contingent on the US avoiding a recession.
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