I’m not saying interest rates are going to go back up. I just think they’re done coming down. One of the basic tenets of my thesis is that in the next five to 10 years, interest rates will not be constantly coming down or constantly ultra-low. And if that’s true, I think we’re in a different environment, and that’s a sea change.  

~ Howard Marks, June 2023

The overall conclusion, then, is that—with the expected slowdown corporate profit growth and no offsetting expansion in P/E multiples—real longer-run stock returns in the future are likely to be no higher than about 2 percent, the rate of GDP growth. While this conclusion is certainly dramatic, it follows from minimal assumptions. The main assumptions are that interest and corporate tax rates cannot fall much further below 2019-levels. Everything else logically follows…

~ Michael Smolyansky, Federal Reserve Board Finance and Economics Discussion Series, June 2023

Editor’s Note: This is Part II of Volume II, Issue VI of The Macro Value Monitor. Part II, The Growing Apprehension of the Inflating Fiscal Put, can be found here. To listen to The Macro Value Monitor, click on the headphones icon in your Substack app.

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As we have discussed over the past couple of years, the growing tension between the Federal Reserve’s monetary policy and the Federal Government’s fiscal deficit will likely be a major theme in the years ahead.  As was shown earlier, we remain in the middle of the steepest part of the rise of the number of retirees relative to the working population.  The labor market is only just beginning to show outward signs of the growing relative scarcity of workers, and the inflation associated with this lack of labor supply is likely just beginning. 

At the same time, the impact of higher interest rates on the Federal deficit is only just beginning as well, and it will be interesting to see how the Federal Reserve attempts to balance the need for tighter monetary policy with the inflationary impact of larger deficits on the economy in the years ahead.  The policy dynamic created by the $32 trillion federal debt – higher interest rates to counter inflation begetting larger fiscal deficits that fuel inflation – has the potential to be a virtuous cycle that keeps average inflation rates much higher in the years ahead than they have been over the past two decades.

If so, this dynamic will represent a big problem for a generation of investors in U.S. stocks.