The Ups and Downs of the Global Economy

10.01.2016.

It seems like a lot of time has passed since the world went into recession in 2008 but here we stand with over half the world’s nations still in financial difficulty. For many of them the situation is only getting worse; after seven years of gloomy global news the emerging markets are looking like their struggle is only going to get worse.

According to the Economist there are three types of emerging market economies: the first group including South Korea, Singapore and, more significantly, China has enjoyed the unparalleled credit boom gifted by the US Federal Reserve in recent years where the historically low interest rate has pulled money out of the richer economies and into the poorer ones.  These economies binged on cheap dollars to finance imprudent investments or purchase overpriced assets.  This first group probably has enough cash to withstand the shock of capital withdrawal but it won’t be without a prolonged hangover.

The second group is the most problematic, with Brazil at its centre running a corporate bond market that is twelve times the size it was in 2007.  Its reliance on foreign capital and the current political stalemate almost guarantee its failure and the country is far from nimble enough to respond adequately to avert disaster.  Other countries such as Turkey and Malaysia are likely to be similarly affected with their large economies, huge liabilities, low reserves and, in Turkey’s case, currency issues.

India and Russia, sitting in the third group, might just escape some of the drama of the other two.  A lot depends however on how skilfully their politicians manage the potential pitfalls and how their economies perform.

All of these factors indicate that an investment in emerging markets might not be a good decision in 2016.  Certainly the risks could be excessive and, if past debt cycles are anything to go by, another year of slowdown is more likely than not.  The developing world now accounts for over half of the global economy, much higher than in past decades.  Lower growth will hit the multinationals and exporting countries.  Additionally, low prices for commodities help oil importers but create pressure on drillers, miners and trading concerns.

All of this will feed back to Europe and the USA but the divergence between these two giant blocs has never been more extreme: on the one hand Europe is most exposed to cooling demand from emerging markets meaning more monetary easing looks likely; on the other a wave of capital returning to America should once again encourage consumers to become borrowers.

Investors should seek some professional advice and look at rebalancing their portfolios as we move into early 2016 – the cost of not doing so could be much higher than you think.

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