More signs emerged last week that we are in the throes of a synchronized global economic recovery, with emerging markets and developed markets seeing improved economic growth. As the Trump administration works to pass its tax reform package, I expect the debate over economic stimulus to accelerate. Is it still needed in a growing economy?
Growth is picking up around the world
In emerging markets, a number of countries are seeing improved growth expectations. The Organization for Economic Cooperation and Development (OECD) revised its expectations for growth in China up to 6.8% for 2017. Russia is benefiting from greater demand for oil, while Brazil is benefiting from monetary policy easing. India is a longer-term story, as it is poised to experience improved growth after reforms such as de-monetization and the implementation of a goods and services tax. As mentioned in The Economist last week, 21 countries in the MSCI Emerging Markets Index have already reported second-quarter gross domestic product (GDP) growth – and all of them experienced improvement over the first quarter.
Developed markets are also participating in the improved growth environment. The OECD has projected that the euro area will grow by 2.1% in 2017, which is up from previous estimates. The same is true for Japan and Canada; the OECD growth estimate for Japan for 2017 was revised slightly upward to 1.6%, and the growth estimate for Canada for 2017 was revised up significantly to 3.2%. Even Greece is experiencing solid growth at a level not seen since 2008. In fact, global GDP growth was revised slightly upward in September by the OECD. It is now projected to rise to approximately 3.5% in 2017 and 3.7% in 2018. The OECD Interim Economic Outlook explained, “The upturn has become more synchronized across countries.” And this momentum is likely to continue given positive sentiment as seen in purchasing managers’ surveys.
This global growth recovery is helping U.S. companies that have exposure to international business. According to FactSet Research Systems, companies that derive more than 50% of sales from outside the U.S. are expected to have an earnings growth rate of 7.9% in the third quarter, while companies that derive less than 50% of sales from outside the U.S. are expected to experience a slight earnings decline (specifically, -0.1%) in the third quarter.1 This is a result of improved global growth as well as a weaker U.S. dollar.
Protectionism could threaten global growth
So what can derail this growth train? The biggest threat is arguably protectionism, which is often an outgrowth of nationalism and even regionalism. We have seen this phenomenon grow in spades in the past year. It made a big splash with the Brexit vote and has not abated since. Economic nationalism helped deliver the U.S. presidency to Donald Trump, while regionalism enabled Catalonia to prevail in its independence vote from Spain last week.
Not only can movements like Catalonia’s create instability and uncertainty – the 10-year Spanish bond yield rose from 1.59% on Sept. 29 to 1.76% by Oct. 4 – but they can also result in barriers to free trade.2 Therefore, we will want to follow developments on this front closely since there could be more nationalism/regionalism on the horizon with secessionist movements active in Scotland, the Kurdish region of Iraq, Flanders, Quebec, and the Basque region of Spain.
Monetary tightening could also threaten growth
Another factor that could derail this recovery is the withdrawal of monetary policy support too quickly. As part of normalization, there needs to be a careful handoff from monetary policy to fiscal policy as the primary policy tool. And that is an important reason why the proposed comprehensive tax reform package in the U.S. deserves scrutiny as the negotiating process begins in Congress. I expect a lot of horse-trading and bartering as the Trump administration works to gain enough support to see it passed. As the bill takes shape, it is worth asking whether each of its provisions will be fiscally stimulative – and, if so, whether the economy needs such stimulus.
Helping in this assessment may be a study just published by the International Monetary Fund (IMF) on fiscal stimulus.3 It shows that fiscal stimulus can have a “spillover effect” in other countries – however its impact is dependent on a variety of factors. For example, the spillover effect tends to be low when a fiscal shock originates from a country whose economy is showing strength. However, the spillover effect is typically higher “when a source or recipient country is in recession and/or benefiting from accommodative monetary policy.” The IMF research also shows that spillover effects from government spending shocks are typically more impactful than those associated with tax shocks. We will want to consider this research as we ponder the different elements of the tax bill being negotiated by Congress. Having said that, we will also want to ensure that fiscal stimulus does not create an overshooting of inflation targets.
This growth reminds us that we must always be vigilant about risks to the downside and the upside, which is why I believe that broad diversification is so important. We must also be mindful of inflation and the effect it can have on portfolios (after all, we did see significant wage growth in the aberrant U.S. jobs report for September). This may include exposure to asset classes and sub-asset classes that have historically held up well to inflation, such as inflation-protected securities, commodities and dividend-paying stocks.