Perhaps the most remarkable trend in global macroeconomics over the past two decades has been the stunning drop in the volatility of economic growth. In the United States, for example, quarterly output volatility has fallen by more than half since the mid-1980’s. Obviously, moderation in output movements did not occur everywhere simultaneously. Volatility in Asia began to fall only after the financial crisis of the late 1990’s. In Japan and Latin America, volatility dropped in a meaningful way only in the current decade. But by now, the decline has become nearly universal, with huge implications for global asset markets.
Investors, especially, need to recognize that even if broader positive trends in globalization and technological progress continue, a rise in macroeconomic volatility could still produce a massive fall in asset prices. Indeed, the massive equity and housing price increases of the past dozen or so years probably owe as much to greater macroeconomic stability as to any other factor. As output and consumption become more stable, investors do not demand as large a risk premium. The lower the price of risk, the higher the price of risky assets.
Consider this. If you agree with the many pundits who say stock prices have gone too high, and are much more likely to fall than to rise further, you may be right—but not if macroeconomic risk continues to drain from the system.
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