Two weeks ago the OECD published their revised outlook for the global economy for 2014 and 2015. Global growth for this year is marked down to 2.7% and to 3.6% in 2014. The nearly half-a-percentage-point reductions as compared with the May projections are due to slower growth in emerging markets. The OECD’s forecast for global growth in 2015 is unchanged at 3.9%.
The projected moderation in the growth of some major emerging markets is due to a deterioration of financial conditions in those economies. Rising long-term interest rates in the US have triggered capital outflows from some emerging markets, particularly those with high external deficits, causing liquidity conditions to tighten and currencies to depreciate. The OECD considers that the vulnerabilities that were exposed will continue to be a drag on economic performance going forward. Other factors cited include weakness in some emerging market banking systems, excessive private-sector credit growth, subdued external demand due to the weak global growth this year, and some moderation in potential growth rates. Nevertheless, the non-OECD countries (mostly emerging and developing economies) are still projected to grow at twice the 2.5% average growth of the (mostly developed) OECD countries over the next two years.
US economic growth is projected at 1.7% this year, 2.9% next year, and 3.4% in 2015, or an average of 3.12% for the 2014-15 period. That projected two-year average growth is higher than for any other developed economy among the 40 economies covered by the OECD outlook. The US ranks 11th in a table comparing the two-year prospects for the 40 economies. The first 10 positions are held by emerging markets, with the first five being China (7.81%), Indonesia (5.66%), India (5.19%), Chile (4.69%), and Mexico (4.00%). The bottom ten are all developed economies, with nine of the bottom ten being in Europe. The recovery in Europe is seen as lagging, with unemployment remaining very high, especially among the young.
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The non-European economy in the bottom 10 is Japan, with a projected average growth of 1.21%, following 1.8% growth in 2013. This surprisingly low projection appears to be due to several of the assumptions used by the OECD. Two are of importance to Japan. The exchange rates used for the projections are fixed at the rates prevailing on October 25, 2013. In particular, the US dollar/yen rate is set at 97.02. That rate today is 102, and we anticipate considerable further depreciation of the yen versus the US dollar over the next two years. That would be an important positive for Japan’s exports and economic growth. Also, the forecasts are based on fiscal policies that either have been legislated or announced and judged very likely to be implemented. In the case of Japan, the consumption tax increases from 5% to 8% in 2014 and to 10% in 2015 are incorporated as well as the announced partially offsetting fiscal stimulus package and a 1 trillion yen tax cut. There would likely be further fiscal stimulus if growth were to slow to the extent projected. These considerations suggest Japan’s growth is more likely to average about 2% over the next two years. We are maintaining our overweight for Japan in our International and Global portfolios.
Another economy for which our projections differ from the OECD’s is China. The OECD’s projections were finalized on November 14, that is, before the release by China of a 20-page master plan of the reforms agreed at the Communist Party’s Third Plenum. Along with a major loosening of the one-child policy and abolishment of the re-education labor camps, the master plan includes a bold and ambitious set of top-down economic and financial reforms that will lead to significant changes in China’s economic model. The market will be allowed to play a “decisive” role (the former language was a “basic” role). The stated objective is to establish a modern market system with market rules and pricing. State-owned companies will be subjected to market forces. They will be increasingly expected to pay market prices rather than obtaining subsidized finance and inputs. State-owned enterprises will be allowed to introduce employee stock ownership plans. Market-based price reforms are coming for utilities, transportation, and telecommunications. Financial sector reforms include a deposit insurance system, interest rate liberalization, and a speeding up of capital account convertibility. The central bank pledges to end “normal” intervention in currency markets and to phase out quotas for institutional investment in Chinese assets. Consideration will be given to adopting a national treatment policy towards foreign investment, combined with a negative list (the common practice in OECD countries) and to setting up intellectual-property courts. Fiscal reforms will be deepened.
Implementing these and other elements of the master plan will be very challenging, with resistance from vested interests in the current system likely to be strong. The process will extend over a number of years, as the Chinese will very likely pursue their typical step-by-step approach to reforms. The direction and boldness of the overall plan, which will contribute significantly over time to the health of the Chinese economy, is commendable. During the next two years there should already be some contributions to economic performance as investors are encouraged by the new direction in economic and financial policies. The average growth rate for the 2014-2015 period could be around 8.5% instead of the 7.8% forecast by the OECD. We are also maintaining our overweight positions for China in our portfolios.
These upward adjustments to the growth projections for the second (China) and third (Japan) largest of the world’s economies have positive implications for the global economic outlook, particularly for other economies in the Asia-Pacific region; for commodity exporters such as Australia, Indonesia, Brazil, and Canada; and for Germany, the European country that has well-developed trading links with China.
We are in broad agreement that the US economy’s growth will lead that of the other developed economies during the next two years. We also agree that the two-year average annual growth rates for most of the economies of continental Europe, aside from Sweden and Switzerland, will be very modest, remaining less than 2%, unless, of course, further stimulative policy actions are taken by the European Central Bank and national authorities.
Our US, International, and Global Equity ETF portfolios are fully invested as we enter the final month of the year. Looking forward to 2014, the economic prospects summarized above should provide a fundamental basis for another positive year for equity markets in general, but with considerable differences in performance among the national markets, as has been the case this year.
In a forthcoming Commentary we will examine the recent forecast records of the widely used economic outlooks produced by the OECD and the IMF.
