Stock Markets at Record Levels, Improving GDP and Low Inflation…How long will it last?

August 29, 2014
Tom Syer

We head into the Labour Day weekend after digesting a recent barrage of mostly positive economic data for the second quarter of 2014 in North America. In the United States, after a tough first quarter, the economy posted an impressive performance in Q2 with 4.2% (annualized) real GDP growth, along with low inflation and solid metrics across several other key indicators. This pickup in GDP growth corresponds with accelerating job creation and modest income gains for American households.

In Canada, the economic expansion has less momentum, but it is also tracking in a positive fashion as the ‘pull’ effect of the stronger US economy takes hold. Canada’s second quarter real GDP growth came in at 3.1% (annualized), with inflation running at 2.1% and a bounce in job creation in July.

Also worthy of mention in the wider North American context is the rebound of GDP growth in Mexico to just over 4% (annualized) in the second quarter.

At the same time, stock markets have continued their ongoing bull run, with indexes reaching record highs in the major North American exchanges.

Which all begs the question, how long will this last?

Can the reviving US economy propel a stronger global growth scenario even as the Eurozone slips closer to recession, Japan continues to struggle, and China (and other emerging markets) find a slower (but still positive) growth track?

This is a complex question with numerous (short and medium term) factors and events to consider, leading to a multitude of different scenarios. However, from a historical perspective that’s based on examining some of the key factors driving business cycles, the empirical evidence points to a reasonably favourable picture.

The two charts below provide summaries of evaluations of where the ‘business cycle’ is currently at:

Fidelity Investment – Stages of Business Cycle, Current Analysis

Bank of America Merrill Lynch Fund Manager Survey – Global Perspective on Business Cycle

While it is notoriously difficult to predict the exact length of a business cycle – the factors are unique for each cycle – the range in the 11 US business cycles over the post war period has been from approximately 3.5 years to just over seven years. The current US economic expansion began in the third quarter of 2009 and has now lasted for five years; Canada has followed essentially the same cyclical path. With no evidence of worrisome upward inflation pressure in either country, there is no reason to expect the Federal Reserve or the Bank of Canada to push their policy interest rates higher in the short-term – and once rates do start to climb, the increases will likely come in small, predictable increments rather than big jumps. The best guess at this stage is that barring unforeseen developments, we probably have at least two more years of positive economic growth to look forward to in North America.

How robust that growth will be is of course open to debate. To date the economic upcycle following the 2008-09 recession has been sub-par in the US and (to a lesser extent) in Canada. However, staying on a positive economic growth trajectory is clearly better than the alternative.

Now as for the stock market… Perhaps a blog for another day…

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