Plentiful liquidity remains a dominant feature of the economic and market environment and is sustaining the equity-favorable reflation process that began in 2002. Expect equities to continue outperforming bonds, and foreign equities to outperform U.S. equities, although in both cases it will be less dramatic than in recent years.
For now, expect the global boom to continue. As a result, the following industries will continue to benefit: infrastructure, materials, consumption, travel and leisure, the expansion of financial services abroad, and environment-oriented capital spending.
Analysts are observing a crescendo in liquidity conditions. Global real interest rates remain low by historical standards, and gold and commodity prices have risen to high levels. Foreign central banks are adding rapidly to reserves, and several global measures related to money supply growth have been accelerated.
Expect U.S. inflation to remain elevated due to past dollar weakness. Even the U.K., with a strong pound and higher interest rates than the U.S., has an inflation problem. And, expect the Fed to follow the lead of the other major central banks in 2007 who instituted rate hikes. The ECB is likely to hike in June, the U.K. in the third quarter, the Bank of Japan in the third and fourth quarters, and China regularly.
Analysts are concerned about moral hazard - in this case, the expectation of rate cuts in the event of a financial disruption - distorting the prices of financial assets and temporarily lowering its volatility. However, at this point, analysts don’t think that the excess liquidity will necessarily cause an ending of this expansion, and when it eventually comes, they don't expect it to be unusually bad. The real economy has not yet seen a fatal degree of excess – inventories are low, many investments are aimed at productivity enhancement rather than merely the anticipation of higher prices, and the U.S. home-building boom of 2004-2005 has significantly corrected itself.
Analysts think that the U.S. second-half growth will be solid, taking note of steady growth in consumption, and the prospect that other parts of the economy will also pick up. These include inventories, trade, government spending and business investment.
The housing correction is running its course. Retailing was weak in April after fast gains in February and March, and at any rate, is a declining part of the GDP. Recent favorable data includes low initial jobless claims, ISMs, and industrial production. Favorable leading indicators include stock prices, credit spreads and corporate profits.