Wednesday, July 30, 2014

A Brief Note On The Second Quarter

  • Both nominal and real growth remain subdued.
  • There are no signs of acceleration.
  • The bond market has over-reacted.

On a YoY basis, RGDP is growing at 2.4% and NGDP is growing at 4%, far below the growth rates of the Clinton and Bush years. The low level of real growth reflects the low level of nominal growth, because you are not going to have 4% real growth along with 4% nominal growth. Nominal growth should be at least 6.5% if we ever wish to see 4% real growth again. The core problem is that the Fed’s 2% inflation target is much too low; and the FOMC has tolerated below-target inflation since the Crash.

Given that the economy has been stalled for the past four years, and given that the Fed is in the process of withdrawing stimulus, there is no reason to expect higher growth or inflation. Bond yields are unlikely to rise substantially against such a backdrop, and today’s selloff will prove to be a blip.

Investment Conclusion
The economy is not accelerating at a pace that should raise bond yields. Low bond yields sustain the wide equity premium (5.4% according to Aswath Damodaran).

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