Derek Hamilton
International Economist
Ivy Investment Management Company
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Over the past year, the global economy has been quite volatile. After experiencing the worst global downturn since the Great Depression, governments and central banks were able to stabilize the economy, and we have returned to positive growth rates. Throughout this volatility, most emerging market economies have outperformed their developed peers. Where do we go from here?
Selected emerging and developed markets poised to strengthen
Emerging market economies, including China, have weathered the economic crisis very well as fiscal and monetary stimulus boosted domestic demand. Despite the global turmoil, Chinese gross domestic product grew by 8.7 percent in 2009 and we believe is likely to grow in excess of 10 percent in 2010. A similar story may be seen in most emerging market economies, particularly Asia and Latin America. As the global economy gradually recovers, improvement in foreign trade should add to growth, further boosting economic output. We think this should result in growth in emerging markets continuing to outperform that in developed markets.
In the developed world, we believe growth should continue to gradually recover. The U.S. economy appears to have rebounded from the depths of the worst downturn since the Great Depression. The U.S. economy (as measured by gross domestic product) rose 5.7 percent in the fourth quarter of 2009 after rising 2 percent in the third quarter. Much of that increase is due to inventories, which we think should continue to add to growth in the first half of 2010. In addition, roughly 50 percent of the 2009 stimulus package is scheduled to hit the economy in 2010. We believe these two areas alone should ensure a continued recovery in U.S. growth, at least in the first half of the year. However, consumer spending should remain soft, albeit showing positive growth. While spending habits have changed, and the propensity to save has increased, the shift from job losses to job growth should have a positive effect, keeping consumer spending growth positive. Inflation should remain muted. While headline consumer prices will likely show an increase due to higher oil prices, core prices (ex food and energy) should remain tame due to excess industrial capacity and labor.
Eurozone countries may restrain Europe’s recovery
Our outlook for Europe remains mixed. Countries like Germany and France continue to recover from the recent downturn and should see positive growth, albeit less than in prior recoveries. The main issue with Europe continues to be with what are called the periphery Eurozone countries. These countries (such as Spain, Greece, Ireland and Portugal) benefited from the easy credit environment of the last decade. Now that the access to easy credit is gone, these countries will likely be a drag on European growth rather than a benefit. Greece, in particular, has been in the news as of late. The Greek government is attempting to get its finances in line after years of overspending. In the current environment, the market is unconvinced that the government will follow a stringent plan to reduce the budget deficit and overall debt levels, bringing fears of default. Actual default is possible, but unlikely in our opinion, given that it could cause contagion into other peripheral countries. If Greece gets to the point of default, we believe European authorities and/or the International Monetary Fund would step in to prevent further damage to other European countries. Regarding inflation, we think Europe will be similar to the United States, as headline inflation should pick up while core inflation remains muted.
Remaining risks
For us, the biggest worry in Asia is the risk of inflation. As stated earlier, Asian economies have weathered the downturn well and should continue to show improvement. As the global economy recovers, commodity prices could continue to rise. Given Asia’s general lack of commodities, any sudden rise in prices would likely be a hit to growth and inflationary. Were commodity prices to rise sharply as the global economy recovers, inflation in this region could be higher than expected. The risk is that policy makers would react to this inflation by tightening more than expected, thereby slowing growth. Recently, China has begun to remove its accommodative policy and markets have not reacted favorably. More aggressive tightening due to inflationary pressures would not be received well. While we believe that policy makers will err on the side of caution and will not want to abort the recovery, this cannot be guaranteed.
Another risk deals with some calls in the market for a “doubledip” in developed economies; in other words, the economy going back into recession. Given the amount of policy stimulus put into place, the risk of a double-dip seems low to us. To be sure, government stimulus in many parts of the world will likely be less this year than last. However, with stimulus currently in place to encourage spending by consumers and companies, moderate growth is likely. Therefore, in our opinion, a “doubledip” is possible, but not probable in the immediate future.
As stated earlier, the Greek situation is a risk. But Greece highlights an overarching risk for the globe, and that is the rapid increase in government debt up to and during the crisis. The countries that need to cut government spending are not just smaller countries like Greece or Portugal; rather, large countries like the United States and United Kingdom have large budget deficits that will take time to bring into line. Concerns regarding sovereign risk and the potential for default could be an overhang across the globe.
To be sure, there are many uncertainties for 2010. Will growth be sustained once government stimulus is removed? How will monetary policymakers respond now that we are in recovery?
Will the fiscal problems in Greece and elsewhere become a bigger and broader problem? Despite these uncertainties, we believe that global economic growth will remain positive, with strong first-half growth boosted by inventories. Second-half growth should be softer than first half as inventories normalize and remaining fiscal stimulus wanes.
Past performance is not a guarantee of future results. The opinions expressed are those of Derek Hamilton and are not meant as investment advice or to predict or project the future performance of any investment product. The opinions are current through December 31, 2009, and are subject to change due to market conditions or other factors. Investment return and principal value will fluctuate, and it’s possible to lose money by investing. International investing involves additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets.
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Past performance is no guarantee of future results. The Ivy Funds are managed by Ivy Investment management Company and distributed by its subsidiary, Ivy Funds distributor, Inc.