WORLD ECONOMY EITHER GROW OR SHRINK AS OF TODAY?

Since the beginning of the year, the world economy has faced a new bout of severe
financial market volatility, marked by sharply falling prices for equities and other
risky assets. A variety of factors are at work: concerns about a hard landing for the
Chinese economy, worries that US growth is falteringat a time when the Federal
Reserve has begun raising interest rates, fears of escalating Saudi-Iranian conflict
and signs most notably plummeting oil and commodity prices of severe
weakness in global demand.
And theres more. The fall in oil prices, together with a lack of market liquidity, the
rise in the leverage of US energy companies and that of energy firms and fragile
sovereigns in oil-exporting economies, is stoking fears of serious credit events and
a systemic crisis in credit markets. And then there are the seemingly neverending
worries about Europe, with a British exit from the European Union becoming more
likely, while populist parties of the right and the left gain ground across the
continent.
These risks are being magnified by some grim medium-term trends
implyingpervasive mediocre growth. Indeed, the world economy in 2016 will
continue to be characterised by a new abnormal in terms of output, economic
policies, inflation, and the behaviour of key asset prices and financial markets.

So what, exactly, is it that makes todays global economy abnormal?

First, potential growth in developed and emerging countries has fallen because of
the burden of high private and public debts, rapid ageing which implies higher
savings and lower investment and a variety of uncertainties holding back capital
spending. Moreover, many technological innovations have not translated into
higher productivity growth, the pace of structural reforms remains slow and
protracted cyclical stagnation has eroded the skills base and that of physical
capital.
Second, actual growth has been anaemic and below its potential trend, owing to the
painful process of de-leveraging under way first in the US, then in Europe, and
now in highly leveraged emerging markets.
Third, economic policies, especially monetary policies, have become increasingly
unconventional. Indeed, the distinction between monetary and fiscal policy is
increasingly blurring. Ten years ago, who had heard of terms such as ZIRP (zerointerest-rate policy), QE (quantitative easing), CE (credit easing), FG (forward
guidance), NDR (negative deposit rates) or UFXInt (unsterilised FX intervention)?
No one, because they didnt exist.

But now, these unconventional monetary policy tools are the norm in most
advanced economies and even in some emerging market ones. Recent actions and
signals from the European Central Bank and the Bank of Japan reinforce the view
that more unconventional policies are to come.
Some alleged that these policies and the accompanying ballooning of central
banks balance sheets were a form of debasement of fiat currencies. The result,
they argued, would be runaway inflation if not hyperinflation a sharp rise in
long-term interest rates, a collapse in the value of the US dollar, a spike in the price
of gold and other commodities, and the replacement of debased fiat currencies with
crypto currencies such as bit coin.
Instead, and this is the fourth aberration, inflation is still too low and falling in
advanced economies, despite central banks unconventional policies and surging
balance sheets. The challenge for central banks is to try to boost inflation, if not
avoid outright deflation. At the same time, long-term interest rates have continued
to come down in recent years, the value of the dollar has surged, gold and
commodity prices have fallen sharply and bitcoin was the worst-performing
currency of 2014-2015.

The reason that ultra-low inflation remains a problem is that the traditional causal
link between the money supply and prices has been broken. One explanation for
this is that banks are hoarding the additional money supply in the form of excess
reserves, rather than lending it in economic terms, the velocity of money has
collapsed. Moreover, unemployment rates are high, giving workers little
bargaining power. And a large amount of slack remains in many countries product
markets, with large output gaps and low pricing power for companies an excess
capacity problem exacerbated by Chinese overinvestment.
And now, following a massive decline in housing prices in countries that
experienced a boom and bust, oil, energy and other commodity prices have
collapsed. Call this the fifth anomaly the result of Chinas slowdown, the surge in
supplies of energy and industrial metals (following successful exploration and
overinvestment in new capacity) and the strong dollar, which weakens commodity
prices.

The recent market turmoil has started the deflation of the global asset bubble
wrought by QE, though the expansion of unconventional monetary policies may
feed it for a while longer. The real economy in most advanced and emerging
economies is seriously ill and yet, until recently, financial markets soared to greater
highs, supported by central banks additional easing. The question is how long Wall
Street and Main Street can diverge.
In fact, this divergence is one aspect of the final abnormality. The other is that
financial markets havent reacted very much, at least so far, to growing geopolitical
risks, including those stemming from the Middle East, Europes identity crisis,
rising tensions in Asia and the lingering risks of a more aggressive Russia. Again,
how long can this state of affairs in which markets not only ignore the real
economy, but also discount political risk be sustained?
International Monetary Fund: Global Economy to Slow Down in 2015
Global growth to slow further
The IMF (International Monetary Fund) recently came out with an update on its
World Economic Outlook projections from April 2015. The July update
estimates that the global economy will grow by 3.3% in 2015. In April, the IMF
had expected the worlds economic growth to rise by 3.5% in 2015. For more
Market Realist coverage on this topic, read International Monetary Fund: Global
Growth Disparity to Widen.

Enlarge Graph
The primary reason for the update
The global economy experienced lower-than-expected-growth in 1Q15,
especially in North America. This is why the IMF expects global economic output
in 2015 to be affected.
The IMF isnt overly concerned, though. The agency maintains that factors capable
of accelerating economic growth in advanced nations, including favorable
monetary policies, low fuel prices, and improving labor markets, among others, are
still in play. These factors have the potential to get the global economy back on
track.

How does this affect you?

Slower-than-expected growth in a country or a region is not a favorable sign for
investors. If economic fundamentals have weakened and are affecting growth,
financial markets in that area will, sooner or later, experience lower returns as well.
At the end of the day, a slow-growing global economy can impact ETFs such
as the iShares MSCI ACWI ETF (ACWI) and the Vanguard Total World Stock ETF
(VT).
Nations may emerge from a downturn quicklyin macroeconomic termsor may
face years, even decades, of stalled growth. Japan is a case in point. The Japanese
economy failed to grow for decades, impacting financial markets and related
instruments as well as stocks, especially financials including Sumitomo Mitsui
Financial Group (SMFG), Mitsubishi UFJ Financial Group (MTU), and Mizuho
Financial Group (MFG).
In this series, well look at the IMFs expectations for economic growth across
regions and countries, and well explore how these projections might affect your
investments.
In the next article, well look at why the IMF expects global economic growth to
slow down.
Must-Know Factors Expected to Affect Global Economic Growth
IMF forecast
The IMF (International Monetary Fund) updated its April World Economic
Outlook projections earlier in July. In the update, the IMF highlighted four major
factors that have impacted its projections:

weak 1Q15 economic growth

inflation
a rebound in oil prices
a rise in bond yields
Lets take a look at each of these.

Enlarge Graph
Weak 1Q15 economic growth
In April 2015, the IMF expected the world economy to grow at a ~3% pace in
1Q15. This pace was also reflected in its forecast for the full year. However, an
unexpected contraction in US economic growth during this period, as well as its
spillover effects in Canada and Mexico, forced the agency to revise its forecast
downward.
The US economy was affected by a harsh winter that kept consumers away from
department stores including Macys (M), JCPenney (JCP), and Kohls (KSS). A
labor dispute at the West Coast ports also held back economic output, as exports
were stuck at those ports.
Weak economic output worried investors across market caps in ETFs such as the
Vanguard Total Stock Market ETF (VTI) and the Schwab US Broad Market ETF
(SCHB). However, positive signals from policymakers in the US regarding future
economic growth there has calmed investors that were worried about a sustained
slowdown.

Inflation
The IMF maintains that headline inflation has begun to bottom out in many
advanced nations. This means that a downtrend in inflation is expected to
end. However, the agency notes that the effect of deflationary factors was stronger
than expected, particularly in the US.
Investors should note that inflation bottoming out is not equivalent to a rise in
inflation. It will take time before central banks around the world see inflation rising
to levels acceptable to them. Once they do, monetary policies may be adjusted
accordingly.
A rebound in crude oil prices has a lot to do with the notion that inflation is
bottoming out. Lets look at that, and the fourth factorrising bond yieldsin the
next article of our series.
IMFs Global Economic Growth Projections Colored by Oil, Yields
A rebound in oil prices
In an update to its April 2015 World Economic Outlook projections, the IMF
(International Monetary Fund) said in July that crude oil prices rebounded more
than expected in 2Q15. The report notes that this higher-than-expected rise was
due to higher demand and hopes that oil production growth in the United States
will slow faster than previously forecast.
Though the oil price rebound has softened some losses, ETNs and ETFs
including the iPath Goldman Sachs Crude Oil Total Return Index ETN (OIL) and
the United States Oil ETF (USO) have still fallen by double digits year-to-date.

Enlarge Graph
The IMF expects the annual price of crude oil to average $59 a barrel, consistent
with its expectations in April 2015. However, it has reduced its forecast for 2016
and subsequent years, as oil supply is still well above what it was in 2014 and oil
inventories globally are continuing to rise.
Reduced drilling activity in the US has impacted stocks including Transocean
(RIG), Diamond Offshore Drilling (DO), Rowan Companies (RDC), and Atwood
Oceanics (ATW).
The IMF expects that less investment in this area will affect economic activity in
North America in general and in the US in particular.
A rise in bond yields
This is the fourth major factor the IMF highlights in presenting its revised
projections in the July update. The IMF notes that yields on long-term government

securities have risen by about 30 basis points in the United States and by about 80
basis points on average in the euro area (excluding Greece) since April. But
conditions for retail and corporate borrowers have remained favorable in general.
According to the agency, higher yields, in part, reflect an uptick in economic
activity and a possible bottoming out of inflation.
What do these projections mean for investors? Lets start by discussing growth and
investment options in advanced and emerging economic in the next article.
Slowing Global Growth: Time to Invest in Advanced Economies?
A double-track world economy
In a July update to its World Economic Outlook, the IMF (International
Monetary Fund) expects global growth to slow more in 2015 than it had projected
it would in April. Yet, its important to note that the world economy isnt expected
to slow down in a uniform way. Instead, the IMF expects advanced nations to
experience a gradual pickup in economic growth, while emerging nations are
expected to experience a slowdown.

Advanced and emerging economies

The IMF expects advanced economies to grow by 2.1% in 2015, compared to 1.8%
in 2014. The forecast has been revised downward by 0.3% from the April forecast
because of unanticipated weakness in North America, which accounts for the
bulk of economic growth among developed nations. Meanwhile, the IMF believes
that this slowdown in North America is only temporary.
Economic growth in emerging markets and developing economies is projected to
slow down to 4.2% in 2015, compared to 4.6% in 2014. The projection for 2015 is
0.1% lower than it was in the April outlook. Commodity prices are expected to
take a toll on these nations.
What can you do?
Its time to review your investments in advanced economies, if you havent already
done so. Emerging market equities have been favorable for some time. But if

economic growth in these areas is expected to slow down, stocks such as China
Mobile (CHL), China Life Insurance Co. (LFC), and Banco Santander (BSBR)
from Brazil will also be affected.
You may consider paring down your emerging market exposure with ETFs such
as the iShares MSCI Emerging Markets (EEM) and the Schwab Emerging Markets
Equity ETF (SCHE).
With economic activity expected to pick up in the US, and output gaining in
Europe, you may consider investing in these areas with ETFs such as the Vanguard
Total World Stock ETF (VT).
In the next article, well look more closely at the IMFs projections for North
American economies.
What Are the Growth Projections for North American Economies?
Unites States
Forecasted 2015 economic growth in the US was revised downward by 0.6% by
the IMF (International Monetary Fund) in the July update to its April World
Economic Outlook. The US economy is now expected to grow at a 2.5% pace in
this year. Growth for 2016 was downwardly revised by 0.1% to a 3% pace.
These downward revisions can primarily be attributed to unexpectedly tepid
growth in consumer spending. Even with a robust labor market, wage
increases have been subdued. A rise in wages usually takes place after economic
activity is firmly set on a growth path.
Though US consumers gave department stores a miss, they continued to shop
online. This benefitted online retailers, including Amazon (AMZN), Liberty
Interactive (QVCA), eBay (EBAY), and the online sales of companies such
as Walmart (WMT) and Apple (AAPL).
Some effects of lower-than-expected growth in 1Q15 consumer spending are
supposed to linger for the remainder of 2015. Nevertheless, expectations are that
this trend will reverse as the year progresses.

Canada
Canada is expected to feel the effects of slower-than-expected growth in the US
due to its close economic ties with the nation. Projections from the IMF
say Canadas economy will grow by 1.5% in 2016, 0.7% less than it projected in
April. In 2016, however, Canadas economy is expected to grow at a 2.1% pace, an
upward revision of 0.1%.
Investors in the iShares MSCI Canada ETF (EWC), among other Canada-focused
instruments, should watch US economic and labor market metrics closely. They
should also watch domestic indicators to determine the allocation of their
investments in Canadian stocks.
Mexico
Like Canada, Mexico will also feel the effects of a slowing US economy. The
countrys economy, which was expected to grow at a 3% pace this year, is now
expected to grow only at a 2.4% pace. Though Mexico doesnt have the same
problems as Brazil, investors in Mexico-focused instruments such as the iShares
MSCI Mexico Capped ETF (EWW) would do well to inspect macro data
emanating from the country closely.
Next, lets move on to Europe to see how well that regions economy is expected to
grow.
IMFs Economic Growth Expectations for Eurozone Largely the Same
The Eurozone
In its recent update, the IMFs (International Monetary Fund) economic growth
projections for the Eurozone, including Lithuania, are unchanged at 1.5% for
2015. That said, the agency is slightly more optimistic about economic growth in
the region in 2016 than it was in April. It expects the regions economy to grow by
0.1% to 1.7% in that year.
Enlarge Graph
Since the ECBs (European Central Bank) latest stimulus measures came in to
effect in March 2015, the regions economy has received a fillip. This shows in the

performance of equities and ETFs tracking the regions indices, including the
WisdomTree Europe Hedged Equity ETF (HEDJ), which has risen by ~19% yearto-date. Meanwhile, the non-currency hedged iShares MSCI Eurozone ETF (EZU)
has risen by over 9% in the same period.
Emerging Europe
There was no change in the economic growth projection for emerging and
developing Europe in 2015. The IMF expects this region to grow by 2.9% this
year.
ETFs including the SPDR S&P Emerging Europe ETF (GUR) and the iShares
MSCI Emerging Markets Eastern Europe ETF invest in stocks of countries in this
region. Investors should be cautious though, as these ETFs are yet to gain traction
in terms of volume. Also, both of these ETFs have significant exposure to Russian
stocks48% and 66%, respectively.
Since the country is susceptible to geo-economic uncertainty, investors should
tread carefully. Consider all the risks before investing in, for example, Russian
stocks such as Mobile TeleSystems Public Joint Stock Company (MBT), Qiwi
(QIWI), and Open Joint Stock Company Gazprom (OGZPY), among others.
The United Kingdom and Spain
The UK (United Kingdom) saw a downward revision in projections for economic
growth in 2015 and 2016. The IMF expects the nations economy to grow by 2.4%
in 2015 and by 2.2% in 2016, down 0.3% and 0.1%, respectively, from its April
projections.
On the other hand, the IMF report was positive about growth in Spain, where it
sees a faster rise than expected3.1% in 2015 and 2.5% in 2016, respectively.
These projections are 0.6% and 0.5% higher than figures in the April report.
Investors in the iShares MSCI United Kingdom ETF (EWU), the iShares MSCI
Spain Capped ETF (EWP), and other instruments that provide exposure to these
two countries should keep a close watch on the macroeconomic picture in these
nations, especially in Spain.

From Europe, lets move to another region that has been the subject of evaluation
by investors in recent timesAsia.
Can China, Japan Give Your Portfolio an Edge?
Japan
The year began with investors debating about whether investing in Japan was a
viable option. The debate continues, and you can read our assessment of Japans
standing in our series, Is It a Good Time to Invest in Japan? While you make up
your own mind, it may help to know that the iShares MSCI Japan ETF (EWJ) has
returned over 15% year-to-date. The question is whether it can sustain this rise.

Japan has benefitted from the economic stimulus delivered by Shinzo Abes
government. His administration is now focusing on implementing structural
reforms in the economy. For more on this topic, read Its Time for the Third
Arrow of Abenomics in Japan.

If structural forms have the desired impact, Japans economy will return to the
growth path in the longer term, and its output will rise more than the 0.8%
estimated by the IMF (International Monetary Fund) for 2015.
China
Japanese equities wont be able to sustain high returns until long-term solutions to
structural problems in the economy are found. China has recently been dealing
with a similar issueequities that run up ahead of economic fundamentals are
bound to obey the laws of gravity at some point.
Chinas economic pace is expected to slow, partly because of deliberate measures
to cool off certain sectors of the economy that were overheating, and partly
because a perennially high growth rate is neither possible nor sustainable.
The correction in Chinese stocks has had a big impact on stocks including E
Commerce China Dangdang (DANG), 58.com (WUBA), and 500.com (WBAI).
The iShares China Large-Cap ETF (FXI) has also fallen by over 15% in the past 13
weeks, despite a rally in the past few days.
The Chinese economy is expected to slow to a 6.8% pace this year and again, to
6.3% in 2016. Though these estimates are unrevised from those laid out in April,
investors would do well to be cautious and scrutinize the macroeconomic factors
that are affecting China.
Next, lets look at India and the ASEAN-5 (defined by the IMF as Indonesia,
Vietnam, the Philippines, Malaysia, and Thailand) region.
IMF Economic Update: Still Upbeat on Some Emerging Economies
Economic prospects for India
The IMF (International Monetary Fund) left its economic growth projection for
India unrevised in its July update of a report originally issued in April. The agency
expects the Indian economy will grow by 7.5% in both 2015 and 2016. These are
strong numbers for any nation given the current macroeconomic circumstances.

Investors should note that these projections are calculated based on the fiscal year.
And in India, the fiscal year begins in April and ends in March the following
calendar year.

ASEAN-5
The IMF defines the ASEAN-5 as Indonesia, Malaysia, Vietnam, the Philippines,
and Thailand. In case youre wondering about the instruments that allow you to
invest in some of these nations, you can refer to our series, Are You Thinking about
Diversifying Your Portfolio? The series also provides some information on the
macroeconomic picture of these nations as compared to other regions.
The IMF expects this regions economy to grow by 2.9% in both 2015 and 2016.
The 2015 projections in the July update are unchanged from Aprils estimates.
However, expectations for growth in 2016 were revised downward by 0.3%.

Whats in it for investors?

First, irrespective of how strong economic fundamentals look, investors should be
careful about investing in emerging markets and other economies that are relatively
unknown to them. Shots in the dark can hit a bulls-eye once, but can sting several
times, too.
Thats not to say that investing in emerging nations should be avoided. Depending
on ones risk appetite, such investments should be used for diversification, as they
provide exciting opportunities and may give that required edge to your portfolio.
Though Indian equities have corrected recently, macroeconomic fundamentals
arent pointing to a crash. You can read more about this in our series, Will the
Indian Stock Market Crash in 2016?
The iShares MSCI India ETF (INDA) and the WisdomTree India Earnings ETF
(EPI) provide exposure to Indian stocks including ICICI Bank (IBN), Dr. Reddys
Laboratories (RDY), and Infosys (INFY).
Meanwhile, the iShares MSCI Emerging Markets ETF (EEM) and the Vanguard
FTSE Emerging Markets ETF (VWO) invest in the ASEAN-5 countries, as well as
other emerging markets. For country-specific exposure, you could look at the
iShares MSCI Indonesia ETF (EIDO) and the iShares MSCI Malaysia ETF
(EWM).
REFERENCE:

http://www.weforum.org/agenda/2016/02/what-is-making-today-s-globaleconomy-so-abnormal
http://marketrealist.com/2015/07/imf-economic-update-still-upbeat-emergingeconomies/