Thursday, October 21, 2010

Global Economic Growth: The Rabbits and the Tortoises

In an important October 6 address on the International Monetary Fund’s (IMF’s) latest world economic outlook, Director Olivier Blanchard focused on the current recovery’s most significant development:

“The world economic recovery is proceeding, but it is an unbalanced recovery. It is sluggish in advanced countries, and it is much stronger in emerging and developing economies.”

This is a theme we first identified in our April 4, 2009 Outlook, and at the time and in subsequent Outlooks and blogs we emphasized that this unbalanced growth would have important investment consequences. Chief among these would be the rising relative attractiveness of the emerging economies’ equity markets and the stocks of multinational companies positioned to provide products and services to the mushrooming middle classes in these economies.

Mr. Blanchard’s presentation is very useful in explaining the IMF’s view of the sources of this growth imbalance, in quantifying the extent of the gap in 2010 and 2011, and in providing policy options which would help to restore a healthier balance. From an investment perspective, his analysis supports our view that this gap is based on structural factors that will likely continue, and may increase, in the foreseeable future.

According to the IMF, there are three major impediments restricting growth in the U.S. and Europe: weak consumption as households struggle to improve financial security, depressed housing markets, and credit-constraining weakness in their financial systems. The IMF’s 2010 GDP growth forecast for these countries is a modest 2.7%. In sharp contrast are many emerging economies, “where excesses were limited and the scars of the crisis are few.” For these economies as a whole, the IMF predicts 2010 GDP growth of 7.1% with emerging Asia’s surging 9.4% growth rate leading the charge.

The IMF expects even more headwinds will buffet the U.S. and Europe in 2011 as the global recovery enters a new stage. The major drivers of growth dating back to the inception of the recovery were inventory accumulation and fiscal stimulus. As the IMF sees it, “the first one is coming to a natural end and the second one is being slowly phased out.” Going forward, consumption and investment must take the lead. The problem is that consumption and investment in most advanced countries “are still weak and will remain so for some time.” The IMF concludes that GDP growth in these countries will shrink from this year’s 2.7% to 2.2% in 2011. This slowdown will be too anemic to reduce stubbornly high unemployment rates, which in 2011 are expected to be around 10% in both the U.S. and Europe. 2011 GDP growth in the emerging economies will also likely slow, yet will still be a robust 6.4%.

The downward revisions in the IMF forecast are representative of reduced consensus predictions as the economic “soft patch” in the U.S. and Europe has continued into the fourth quarter. Lowered economic growth assumptions will likely result in reduced corporate profit growth estimates as Wall Street analysts direct their attention to 2011. We will explore this subject and its impact on global common stock strategies in a future blog.

For a transcript of Mr. Blanchard’s remarks, see

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