Global Growth Is Picking Up – So Are Geopolitical Tensions

April 29, 2014

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The IMF recently published its latest outlook for the global economy. In summary, the IMF economists state the following:

The global recovery is expected to strengthen, led by advanced economies. Growth in emerging market and developing economies is expected to pick up only modestly.

Global growth is projected to grow by 3.6 percent this year, compared with 3 percent in 2013. For the advanced economies the outlook is for 2.2 percent growth versus 1.3 percent last year. For the emerging and developing economies, the quickening is slight, 4.9 percent versus 4.7 percent, but the rate is over twice that for the advanced economies.

The IMF qualifies this outlook by noting,

However, important downside risks remain – notably a yet-greater general slowdown in emerging market economies; risks to activity from lower-than-expected inflation rates in advanced economies; incomplete reforms; and rising geopolitical tensions.

We agree with both this broad economic outlook and the assessment of mounting risks. In this note we take a closer look at global economic prospects, geopolitical tensions, and their implications for equity markets.

The improved outlook for the advanced economies is fueled by ongoing supportive monetary policies, with central banks continuing to add liquidity and add to their balance sheets. Interest rates are likely to remain low. Also, fiscal drag is lessening. Following a slow first quarter, growth in the world’s largest economy, the US, appears to be picking up. The advance for the year should be close to 3 percent and possibly a bit higher. The UK economy looks likely to advance at a similar rate. The Eurozone’s growth will be less, 1.2 percent, but that’s a lot better than last year’s -0.5 percent. Germany will continue to be the Eurozone’s locomotive, advancing at a 2 percent pace, compared with only 0.5 percent last year. The world’s third-largest economy, Japan, appears likely to go against the improving trend, slowing to close to 1 percent from 2013’s 1.4 percent advance as the stimulus from Abenomics declines. Of course, further stimulus measures along with further yen depreciation could change that outlook.

The prognosis for emerging-market economies is considerably more mixed. Some continue to grow strongly, while momentum has slowed substantially for others. China, the world’s second-largest economy, is the most important by far. While it has slowed from a 7.7 percent pace to about 7.3 percent for the current year, this is much less of a slowdown than many had feared. The current size of this economy means its 7+ percent growth continues to contribute greatly to global economic growth. Brazil’s economy, while showing some positive signs, remains hampered by inappropriate economic policies, rising inflation, and high interest rates. Growth this year will probably be less than 2 percent. Russia’s prospects look worse as Putin’s actions drive both foreign and Russian capital out of the country. On the positive side, both India and Indonesia look likely to register growth rates in excess of 5 percent in 2014. The emerging and developing nations of Asia, as a group, will continue to lead the growth race, advancing by 6.5 percent, much faster than the 2.5 percent growth projected for the Latin America and Caribbean region.

Economic growth does not necessarily translate directly into equity market performance. The effects are translated through their impact on corporate earnings and earnings expectations. Consensus earnings-per-share growth estimates for the MSCI World Index are 8 percent for the current year and 11.3 percent for 2015. Corresponding estimates are 9.5 percent and 8.8 percent for the MSCI Emerging Market Index, 7.7 percent and 12.5 percent for the Stoxx Europe 600, 9.4 percent and 11.0 percent for Japan’s TOPIX, and 8.0 percent and 11.8 percent for the US S&P 500. These numbers appear consistent with a continuation, at a moderate pace, of the positive trend in global equity prices this year. The MSCI ACWI Global Equity Index is up 1.1 percent year-to-date but 5.1 percent over the past three months to date. Considerable variation in national market performances is likely to continue.

The risks to this broadly positive outlook need to be underlined. Heightened geopolitical tensions worry us most. The Ukraine crisis appears to be worsening, as the Geneva agreement between the US, Europe, Ukraine, and Russia fails to bring the hoped-for de-escalation. Putin continues to foment conditions in Eastern Ukraine that he could use to justify Russian military intervention, and the prospect of harsher economic sanctions by the West is rising. Putin, pursuing his vision of a greater Russia, appears ready to accept the costs of isolation and a likely deep and prolonged recession. We have even greater concern about the rising tensions between China and Japan, the world’s second- and third-largest economies. While neither country is as likely as Russia is to act rashly, accidents could happen that could escalate tensions quickly in view of the strong feelings on both sides. Global equity markets would react sharply if either of these situations should boil over.

 

The preceding has been reposted with permission of Cumberland Advisors. The original commentary is available at http://www.cumber.com/commentary.aspx?file=042414.asp. Follow Cumberland Advisors on Twitter at @CumberlandADV.

The ideas and opinions expressed in this blog are those of the author, and they should not be perceived as investment advice or as any other kind of advice.

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