Global Growth: Too Slow for Too Long?

A Look at the IMF's Assessment of the Global Economy

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The International Monetary Fund (“IMF”) warned in its April 2016 World Economic Outlook that global growth was slowing due to a combination of financial risk, geopolitical shocks, and political discords that may require structural, fiscal, and monetary measures to resolve. Managing Director Christine Lagarde characterized the recovery as too slow and too fragile with the potential to have damaging effects on the social and political fabric of many countries.

In this article, we’ll take a closer look at the IMF’s latest report and what it means for international investors over the coming years.

Developed vs. Emerging Markets

The IMF projects that advanced economies will grow at only 2% in 2016 due to weak demand, low productivity growth, and unfavorable demographics. Among developed countries, the U.S. is expected to be the most robust performer with a 2.4% growth rate and a modest uptick in 2017. The Eurozone is likely to experience slower growth at just 1.5% this year and 1.5% next year and Japan could see negative 0.1% growth in 2017 after posting just 0.5% growth in 2016.

Emerging markets are expected to be the worst hit by the prolonged slowdown. Lower oil prices and China’s ongoing economic slowdown is expected to result in just 4.1% growth in 2016 and 4.6% growth in 2017 which is significantly lower than past growth rates. Ongoing recessions in Brazil and Russia could also increase geopolitical risks, although this will be partially offset by strength in India, the ASEAN-5 economies, and Central America.

The IMF believes that the slowdown in trade growth since 2012 is attributable to weakness in economic activity and investment, which account for about three-quarters of the slowdown. The waning pace of trade liberalization and the recent uptick in protectionism continues to hold back growth even though their quantitative impact thus far has been limited.

Numerous Risks Remain

There are many important risks remaining for the global economy that could destabilize global equities and depress future investment and growth. While many of these problems have disappeared by April 2016, there is a possibility that they will resurface given the fragile state of the global economy and underlying risk factors that remain in play. International investors should keep an eye on these key risks when building and hedging their global portfolio.

Some of these financial and geopolitical risks include:

  • Currency Devaluations. China’s move to devalue its currency forced many other countries to pursue similar policies that ended up have an adverse impact on their foreign reserves and investor confidence.
  • Oil Prices. Crude oil prices continue to move at the whim of OPEC and unconventional producers, and any unexpected decisions by these parties could introduce more volatility to a commodity that many emerging markets rely on for growth.
  • Geopolitical Shocks. The Syrian crisis continues to play out throughout 2016 and could cause disruptions to national governments, while Britain’s potential exit from the European Union – dubbed the “brexit” – could destabilize its economy.
  • Chinese Growth. China’s transition from manufacturing to domestic consumption is likely to reduce its long-term economic growth rate, but the big question among investors is by how much and will it cause a so-called “hard landing”.

What It Means for Investors

International investors should take away several key points from the IMF’s latest report and adjust their portfolio accordingly to reduce risk and increase returns.

Some important considerations include:

  • Adjust Exposure. International investors with a lot of exposure to emerging markets may want to reassess their positions given the higher risks associated with these investments relative to the overall market. Or, they should at least ensure that emerging markets aren’t overrepresented in their portfolio or exceeding their risk tolerance.
  • Hedging Positions. International investors may want to consider hedging all or parts of their portfolio in order to reduce risk during these uncertain times. For instance, investors may purchase put options on key indexes or explore using options on the VIX in order to profit from any sudden increases in volatility.

Of course, it’s important that international investors also factor valuations into the mix when evaluating these problems. Emerging markets were significantly sold off throughout 2015, which means that the bearish expectations may have been already priced into the equities.

The Bottom Line

The International Monetary Fund outlined several key concerns in its World Economic Outlook for April 2016. International investors may want to take note of these comments when building their portfolios and hedging risks. In particular, many emerging markets remain exposed to geopolitical and financial risks that could quickly resurface and have a negative impact on emerging market fund flows and equity flows in general.