The US Federal Reserve might be about to raise interest rates again, but it’s not stopping the bulls. Both the Dow Jones and the S&P 500 hit fresh record highs overnight.
The coming interest rate hike has been expected for some time. That’s not necessarily what is getting the market excited.
As far as I can work out, it’s the absence of inflation (in the traditional sense) firing up the bulls. A lack of inflation, along with reasonable economic growth, is a continuation of the ‘goldilocks economy’ that equity markets love so much.
It means the Federal Reserve will continue with its ‘slowly, slowly’ policy of raising official interest rates.
That is, they won’t really raise rates at all. Sure, nominal rates will move slowly higher. But they will only rise to the extent that inflation picks up, meaning the real interest rate will barely move.
And in case you were wondering, it’s the movement in real interest rates that matters for the economy and stocks. (Real interest rates are simply nominal rates minus inflation.)
So where is the inflation?
Ironically, it’s probably the Fed’s vast money printing that is behind the lack of inflation in the US. Traditionally, when the economy recovers, unemployment levels fall and you get a pickup in wage inflation. This feeds into consumer price inflation, and then interest rates rise to ensure things don’t get out of control.
But in May the US unemployment rate fell to a 16 year low at 4.3%. Yet there is hardly any wage inflation to speak of.
This reflects a few things…
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Firstly, decades of loose monetary policy have changed the whole structure of the US economy. It’s now an asset price economy, and the bulk of the gains have gone to the minority via asset inflation.
This doesn’t promote broad employment growth. Rather, it promotes narrow employment growth in relatively lower paying service roles. That’s why you’re seeing low unemployment, but a lack of wages pressure.
On top of that, the official unemployment rate probably massively understates the real employment situation in the US. But’s that’s another issue…
The other consequence of loose monetary policy is that it has unleashed a huge amount of capital to fund new technology. I just mentioned that the Fed’s easy money policy caused asset price inflation rather than the more traditional wage and consumer price inflation.
The beneficiaries of this asset price inflation have ‘spent’ their money funding new technology. You can see this in the thriving venture capital economy of Silicon Valley.
This ‘spending’ of excess capital is not really spending. It’s investing in new technology to find new ways of doing business. This is inherently deflationary.
When you think about it, most forms of new technology are about doing things faster and smarter. It removes middlemen, or lowers the cost of doing business. And it does this through investment in capital, not labour.
Hence the lack of decent employment growth in higher paying industries. And hence, the lack of inflation.
Higher paying jobs should come though. If your kid is in high school right now, their career job probably hasn’t been invented yet. So don’t worry if they don’t know what they want to do. They’ll find out in due course…
A good example is the coming marriage between tech and the car industry. Self driving cars will be a reality within a decade. This will require a huge application of new technology.
Apple is working away on autonomous systems right now. In 2014 it started Project Titan by hiring 1,000 engineers to work on its autonomous car system. Not surprisingly, the project got out of hand and had to be reined in in 2016.
But Apple is pushing on and actively testing its system in self driving cars around San Francisco. And now CEO Tim Cook is becoming more vocal about it. As Bloomberg reports:
‘“We’re focusing on autonomous systems,” Cook said in a June 5 interview on Bloomberg Television that amounted to his most detailed comments yet on Apple’s automotive plans. “It’s a core technology that we view as very important.” He likened the effort to “the mother of all AI projects,” saying it’s “probably one of the most difficult AI projects to work on.”
‘The prospect of self-driving cars has seen a slew of technology companies push into the auto industry, according to McKinsey & Co. Alphabet Inc.’s Waymo unit has signed partnerships with Fiat Chrysler Automobiles NV and Lyft Inc. to develop the technology. And carmakers from BMW AG to General Motors Co. have opened sizable Silicon Valley offices and dedicated hundreds of millions of dollars to acquire autonomous vehicle startups.’
Automated cars will destroy a lot of jobs. But it will create a lot of new ones too.
More importantly for investors though, the new world of technology will destroy a lot of old business models.
The emergence of blockchain technology will be the main destroyer. This is still in the early stages, but it will have huge implications across the banking and finance sectors.
If you don’t know what blockchain technology is, don’t worry. I barely understand it myself. But I know enough to know that it has the potential to be a hugely disruptive force.
When I get my head around it and can explain it in a coherent manner, I’ll let you know. In the meantime, stop worrying about the tiny likelihood of another impending stock market crash, and focus on the coming technology revolution. It will change the world in ways you cannot imagine.