Strong US growth sparks new fears of a bubble

The performance of stockmarkets at the end of last year was lending some support to this fear. At the time of this writing, global equities had gained roughly 24 per cent during 2013 (to December 11).

That is around 20 per cent in real terms, or seven times more than global GDP growth, which is slightly less than the 3 per cent based on the freshest estimates.

The global MSCI index is more than 20 per cent higher than at its previous all-time peak in May of 2008. Are equity markets on the verge of collapse? No.

A cold analysis of both real economies and market valuations shows that stock prices are not particularly stretched, while government bonds are still very expensive, even after a year of underperformance.

As of December 11 2013, the year-to-date performance of total return indices for US Treasuries and euro area government bonds were respectively -2.8 per cent and +2.7 per cent; -1.5 per cent and +2.4 per cent in the case of investment grade credit.

Only high-yield bonds had a strong performance, 7.1 per cent in the US and 9.5 per cent in Europe.

Fundamentals suggest another good year for equities and another weak year for bonds.

There is a caveat, nevertheless: this conclusion holds if – and only if – in 2014, the US economy grows fast enough to be able to pull the remainder of the world through on the path to recovery.

First, why wasn’t this the case in 2013? One year ago, it was already clear that the US private sector was up and ready for growth: consumers had largely repaired their balance sheets thanks to hyperactive fiscal and monetary policies and corporate America was in good shape.

But the malfunctioning of US institutions spoiled the party.

A severe fiscal tightening followed by misunderstandings between the Fed and the markets and, in the end, a lasting government shutdown were enough to shave 0.5 percentage points from US GDP growth.

With the benefit of hindsight, that such shocks have not done more harm to the economy is a testament to the underlying strength of the US.

Which brings us to the outlook for 2014. Assuming that the fiscal tightening does not exceed 1 per cent of GDP and that the Fed does not allow bond yields to rise too fast or too high, the US economy should accelerate significantly, allowing equity markets to absorb the Fed’s reduction of liquidity injections.

Since the other powerhouse of the world, China, is unlikely to slow significantly – Chinese leaders have made it clear that they won’t tolerate growth below 7 per cent – the global economy should accelerate, allowing the ‘global healing’ process to advance further and global trade to recover neatly.

This will be good news for the first exporter in the world, the European Union, where several economies, starting with the UK, Spain and Ireland, have already surprised on the upside.

Will it be sufficient to check the deflationist trend that has emerged clearly enough to be noticed by the European Central Bank? Probably not.

Although a more reactive ECB may surprise markets by easing further, conventionally or unconventionally, the key issue will be the restructuring of the banking system, a pre-condition for a credit-led recovery.

This will be a difficult political battle, but there are reasons to be cautiously optimistic. After all, willingly or not, politicians burnt the bridges behind them when, in 2012, they took the brave decision to move toward a banking union.

Eric Chaney is chief economist at Axa Group and head of research at Axa Investment Managers