The new normal for the world economy may be arriving as the U.S., Europe and China all decelerate simultaneously.
After policy stimulus and inventory-rebuilding pulled the major economies out of recession with 5 percent growth in the first quarter, they are slouching toward a weaker expansion, even as they show signs of dodging a double-dip. Global growth may average 3.25 percent to 3.5 percent in the next three to five years, well below the 4.7 percent pace of the five years leading up to the 2008 slump, estimates Stephen Roach, non- executive chairman of Morgan Stanley Asia.
Behind the deceleration in the long-run noninflationary growth rate: consumer retrenchment in the U.S. and fiscal consolidation in Europe, as well as weaker bank lending and employment in both. Chinese growth also may ebb as the world’s most populous country reorients its economy away from manufacturing and exports.
“Post-crisis headwinds will restrain trend growth in world gross domestic product by 1 to 1.5 percentage points,” said New York-based Roach, who also teaches at Yale University.
The new normal means investors may have to accept lower returns and greater volatility in their portfolios, according to Mohamed El-Erian, chief executive officer of Pacific Investment Management Co. in Newport Beach, California, manager of the world’s biggest bond fund, who helped coin the term.
“It implies a lower overall nominal return” than the historical average of 6 percent to 8 percent, he said.
Stable Returns
The fair value of the Standard & Poor’s 500 Index is 900, according to Jeremy Grantham, chief investment strategist in Boston at Grantham Mayo Van Otterloo & Co. That’s 22.5 percent below the July 23 close of 1,102.66 at 4 p.m. in New York. Today, S&P 500 futures contracts expiring in September fell 0.1 percent to 1,099.7 at 11:34 a.m. in London.
Grantham says developed economies will be “lucky” to grow 2 percent annually for the next seven years, and he favors stocks of companies with high, stable returns and less debt.
“In the end, by hook or by crook, debt levels must be lowered at every level” in the industrial world, he wrote in his quarterly newsletter released July 19 on the company’s website.
Jim O’Neill, chief global economist at Goldman Sachs Group Inc., isn’t so gloomy. While acknowledging the economic cycle “is clearly slowing,” he estimates the global growth trend is about 4 percent and may be rising, driven by emerging markets.
Sign of Strength
“Half the world’s population doesn’t wake up and say ‘credit crisis’ before breakfast,” said the London-based O’Neill, who derived the term BRICs to describe the rising power of Brazil, Russia, India and China.
In a sign of strength, data last week showed the U.K. economy expanded 1.1 percent in the second quarter, the fastest pace in four years and almost twice economists’ forecasts. German business confidence unexpectedly surged to a three-year high this month, according to the Ifo institute in Munich. Its index based on a survey of 7,000 executives jumped to 106.2 from 101.8 in June, the biggest gain since 1990.
“Given how Germany is geared towards the global economy, this indicator should have fallen rather than risen and, if anything, points to a soft landing in the global economy rather than a double-dip scenario,” said Violante di Canossa, an economist at Credit Suisse Group AG.
Forecast Shortfall
Investors may need to manage risk by going beyond traditional diversification strategies of splitting portfolios between stocks and bonds, El-Erian said in an e-mail. That might involve the use of hedges against outsized market declines and other portfolio-insurance strategies. Pimco is planning a fund that will offer protection against market drops of more than 15 percent.
The slowdown in the recovery is evident in recent economic reports, with a UBS AG index showing data worldwide in July increasingly falling short of forecasts for a second month, the worst two-month period since the recession began in 2008.
“There will be possibly a period of slower growth beginning in end markets later this year,” George Buckley, chief executive officer of 3M Co., told analysts on July 22. “This isn’t a double-dip per se,” he added. “It’s just a soft spot and very normal as economic growth takes a breather for a while and adjusts to new circumstances.”
The St. Paul, Minnesota-based company is considered an economic bellwether because its product range spans the automotive, consumer and health-care markets.
Slowdown?
A net 12 percent of fund managers this month predicted the global economy will deteriorate in the next 12 months, the first negative outlook since February 2009, according to a BofA Merrill Lynch Global Research survey of 202 managers overseeing a total of $530 billion.
“There will be a slowdown in the second half of the year,” said Paul Donovan, an economist at UBS in London, who pegs the world economy’s noninflationary cruising speed at about 3.5 percent now compared with about 4.25 percent to 4.5 percent before the crisis. “This is the new future.”
A relapse into recession still is unlikely, given how loose monetary policy is in major industrial nations, Michael Saunders, chief western European economist for Citigroup Inc. in London, wrote in a July 21 report to clients.
The Federal Reserve, European Central Bank and Bank of Japan all have pushed the short-term interest rates they control down toward zero percent and taken other steps, such as buying assets, to revive their economies.
Weak Demand
Much of the deceleration in underlying growth appears likely to come in the industrial world. U.S. consumers are still working off the debts they built up during the housing boom. Since hitting a record $1.39 trillion in the second quarter of 2008, household debt has fallen steadily to $1.35 trillion in the first quarter, according to Fed figures.
“As we look on the loan-demand side, it continues to remain weak as consumers continue to de-lever,” Brian T. Moynihan, chief executive officer of Bank of America Corp., the largest U.S. lender, told analysts in a July 16 conference call.
European governments are in budget-cutting mode as they strive to meet European Union rules to push deficits beneath 3 percent of GDP following the Greek-led debt crisis.
CRH Plc in Dublin, the world’s second-largest maker and distributor of building materials, said July 7 that fiscal consolidation is “adding to uncertainty regarding the pace of economic progress in Europe” amid signs of “some softening in the pace of recovery.”
Pre-Crisis Pace
Cable & and Wireless Worldwide Plc, the London-based provider of telecommunications services, last week forecast full-year profit would be at the “lower end” of estimates following U.K. government spending cuts.
The result of all this austerity is that trend growth in the advanced economies will slow to about 1.5 percent a year from a 2.8 percent pre-crisis pace, Roach said in an e-mail.
While emerging markets will do better, their performance “is unlikely to be strong enough to fully compensate for the slowdown in the industrial world,” El-Erian said.
China, the world’s fastest-expanding major economy, may even see its average growth rate slow as it is forced to adapt to less-robust markets for its exports, said Nariman Behravesh, chief economist for consultants IHS in Lexington, Massachusetts.
“I see a gradual deceleration in trend growth in China, from 10 percent currently to 7 to 8 percent over the next five years,” Roach said. “By shifting away from labor-saving manufacturing-led growth to labor-intensive services, China will be able to maintain full employment and social stability with a lower GDP growth rate.”
Boost Local Demand
U.S. Treasury Secretary Timothy F. Geithner has warned other nations that they can no longer depend on American consumers to power the world economy and must boost demand at home to make up for the shortfall.
Surging imports are starting to cut into U.S. growth. Macroeconomic Advisers lopped 0.8 percentage point off its estimate for the second quarter after the Commerce Department reported on July 13 that the trade deficit widened in May to its highest level in 18 months. GDP rose at an annual pace of 2.1 percent in the period, the St. Louis consulting company forecasts, down from 2.7 percent in the first quarter. Commerce is scheduled to release the figures on July 30 in Washington.
The jump in the trade deficit is bad news for President Barack Obama, who is counting on a doubling of exports during over the next five years to prop up growth as consumers retrench.
Foreign Sales
The U.S. isn’t the only country looking to foreign sales to support its domestic economy. Chinese central-bank adviser Zhou Qiren told Japan’s Asahi newspaper last week that his nation will let the yuan weaken if exports fall sharply. Japanese Trade Minister Masayuki Naoshima said July 21 that the yen’s gains threaten his economy. The yen traded at 87.15 against the dollar at 7:29 p.m. in Tokyo.
Germany relies on exports for about 40 percent of GDP, putting Europe’s largest economy in position to gain from the euro’s 10 percent drop against the dollar this year.
The “fallacy of composition” — too many countries counting on overseas sales to power their economies — represents a downside risk to worldwide expansion, El-Erian said. With foreign opportunities limited, governments may have little option but to begin restructuring to find other drivers of growth and sources of productivity, said Marco Annunziata, chief economist at UniCredit Group in London.
In Europe, that means making it easier to fire and hire workers and opening up markets to more competition, he said. What’s needed in the U.S. is quick action to reform Social Security and health care to reduce their drain on the Treasury.
None of that will be easy. “It’s going to take a long time,” Annunziata said. “We face several years of very slow increases in living standards and sustained higher unemployment.”
