With the bull market and economic expansion at a duration of 8-1/2 years, many are becoming queasy that they could be buying into an expensive market, particularly as low rates and quantitative easing have helped inflate asset prices. As the US Federal Reserve plans to take that away through additional rate increases and a run-off of balance sheet assets, this generally signals that risks are increasingly becoming slanted downward. What’s a recession caused by? When the growth in an economy’s spending exceeds that of its output, this generally leads to inflation by the simple fact that demand exceeds quantity supplied. This leads central banks to raise interest rates to keep inflation manageable – enough to incent consumers to spend but not too high that it reduces consumer confidence. When the central bank tightens monetary policy, it slows the rate of debt growth in the economy, which leads to a fall in spending and a consequent economic contraction. Recessions end when the central bank begins to ease monetary policy, typically by pushing nominal interest rates below the nominal growth rate such that the economy can grow faster than debt can compound. This reduces debt service costs, makes debt cheaper to help facilitate spending, and will also reflate financial assets by lowering the discount rate at which future cash flows are valued. More valuable financial assets creates greater wealth among individuals, which ideally funnels down into greater consumer spending. Where are we currently? In the US, we are proceeding into a period somewhere between the mid- and late-stage of the cycle. Inflationary forces are low, which generally bodes well for the economy and risk assets. This means that the Fed is likely to remain fairly accommodative as it currently is – a 1.00% lower-bound rate and a $4 trillion-plus balance sheet. But as always the Fed’s actions will be monitored. But so long as inflation remains low, the longer this current economic cycle can likely persist. The get a feel for the future trajectory of the US economy I look at bank debit turnover as a proxy for credit creation (and consequent spending transactions) and form a distributed lag model to project out the next 10-12 months. If credit creation/spending look to be on a positive trajectory over this time, the economy is probably fine. I use two separate but similar models and plot out the US stock market trajectory against them, which is an imperfect substitute for nominal GDP. The orange line – representing year-over-year stock market performance as represented by the Wilshire 5000 – is expected to roughly follow the blue line in the future and has generally stuck to this pattern in the past. (click to enlarge) Based on this, it predicts that the stock market will not see the year-over-year returns following the financial crisis, as should be obviously expected, but should hold relatively stable and positive through at least June 2018 at these lower growth trajectories.--I will be updating this monthly; so for non-members, if you wish, consider following by clicking the "Follow" button at the top of this page for future periodic updates.