Ed Yardeni: Stocks now mirror both the 1920s and the 1990s — but those melt-ups were followed by meltdowns “If this is the 1990s all over again, are we in 1994 or are we closer to 1999? ”

Since the start of the 2020s, we’ve been comparing the current decade mostly to the 1920s and the 1970s. However, the S&P 500’s SPX 42.3% melt-up since Oct. 12, 2022, to a new record high last week has us considering whether another period represents a possible analogous scenario, i.e., the second half of the 1990s. We see parallels between conditions then and now that may suggest what’s up ahead for both the stock market and the federal-funds rate, or FFR.

Leading the S&P 500 higher back then was the Nasdaq-100 NDX. That seems to be happening again since the ratio of the latter to the former bottomed on Jan. 5, 2023. We are especially intrigued by the similarity between the recent vertical ascent of Nvidia’s NVDA, +4.00% stock price and Cisco Systems’ CSCO, +0.06% stock price during the late 1990s.

In fact, the second half of the 1990s script might be the most likely scenario for the federal-funds rate over the rest of this decade. Back in the 1990s, stock prices soared. The positive wealth effect boosted economic growth. Inflation was subdued by rapid productivity growth, implying that the inflation-adjusted FFR was in line with the so-called neutral FFR.

Consider the following:

1. Real GDP: The 1990s started with a brief and shallow recession. Real GDP growth rebounded quickly from a low of -1% year-over-year during the first quarter of 1991 to its historical average of 3.1%. During the second half of the 1990s, it fluctuated around 4%-5%.

The current decade started with a brief but severe recession because of the COVID-19 pandemic lockdown in early 2020. It was followed by a very strong recovery. By the fourth quarter of 2023, real GDP was back to the 3.1% historical average growth rate. We expect to see real GDP growing at or above this rate through the end of the decade thanks to solid productivity growth.

2. Productivity: The growth rate of nonfarm business productivity was extremely volatile during the first half of the 1990s. It soared to 5% year-over-year during the first quarter of 1992. Then it plunged to -0.6% during the fourth quarter of 1993. During the second half of the decade, it was back over its historical average of 2%. It peaked at 4.2% by the end of the 1990s.

During the first half of the current decade, productivity growth has also fluctuated widely, from 6.8% during the third quarter of 2020 to negative 2.4% during the second quarter of 2022. But it was back above its historical average at 2.7% at the end of last year. In our Roaring 2020s scenario, we are expecting a productivity growth boom during the second half of the current decade much like the one during the second half of the 1990s.

3. Inflation: In addition to boosting the growth rate of real GDP, productivity (along with hourly compensation) determines unit labor costs (ULC) — the year-over-year percentage change that is the underlying inflation rate. Both ULC and CPI inflation rates fell significantly during the first half of the 1990s. The former dropped from 5.1% in the fourth quarter of 1990 to negative 0.2% in the second quarter of 1994. Over this same period, the CPI inflation rate declined from 6.3% to 2.3%. Over the remainder of the decade, it fell to a low of 1.4% in March 1998 and ended the decade at 2.7%.

In our Roaring 2020s scenario, CPI inflation continues to moderate along with ULC inflation as productivity growth continues to improve. ULC inflation was down to 2.3% year-over-year during the fourth quarter of 2023 from 6.3% during the first quarter of 2022. If productivity growth climbs to 3.5%-4.5% over the rest of this decade, as we expect, that would boost the growth rate of real GDP while keeping a tight lid on inflation.