The Big Trends in the Global Economy

Global Growth

A lot has seemingly happened in the global economy in recent months, from a plunge in the oil price to a surge in the value of the US dollar against foreign currencies to an election in Greece that led to renewed fears about the possibility that the euro zone would break apart. But what’s been the upshot of all these changes? The latest World Economic Outlook report from the International Monetary Fund provides some data to answer that question.

According to the IMF’s report, the global economy is expected to grow by 3.5% this year. That’s lower than the projection of 3.8% growth that the IMF made six months ago. The change is largely the result of slower expected growth from emerging markets (5.0% six months ago versus 4.3% now). The prospects for developed economies, on the other hand, have actually improved slightly. While the estimated 2015 growth for the US hasn’t changed (it’s still 3.1%), the IMF boosted its growth estimates for the euro area and Japan.

Even though expectations have declined for emerging economies as a whole, not every country has a similar story. Six months ago the IMF expected a positive growth rate this year in Russia and Brazil; now it expects both countries’ economies to get smaller. The anticipated growth rate for China has also declined, although it’s still very high at 6.8%. India has gone in the other direction. Six months ago the IMF was projecting that India’s growth this year would be 6.4%. The latest estimate is 7.5%.

It’s important to remember that there’s only a weak link between economic growth and stock market performance, so simply buying stocks of fast-growing countries (or stocks of countries where the economic outlook has improved) probably isn’t a good idea. In fact, China and Russia have been among the best-performing stock markets so far this year. Still, thinking about the global economy in terms of these numbers may make the big-picture trends more apparent.

The Meaning of Lower Corporate Earnings

SP500 Earnings

Few things go up forever, and corporate earnings are no exception. Earnings season began this week as companies started reporting their performance for the start of 2015, and American companies’ earnings are expected to decline compared to the same period last year. Should you be worried that this decline heralds the end of the bull market in stocks that’s lasted since the end of the financial crisis?

The short answer is “not too much.” There’s always some variation in earnings from one quarter to the next, not only for individual companies but also for the stock market as a whole. Such variation even occurs during long periods of stock market gains (such as the current one): there were a couple quarters in 2012 where earnings declined, and US stocks proceeded to soar in 2013.

This quarter’s projected earnings dip may also be largely the result of transient factors. The recent rise in the value of the US dollar against foreign currencies has hurt American exporters by making their products more expensive overseas, and the plunge in the oil price has hurt energy companies. If these trends reverse, or if companies adjust their strategies to adapt to the stronger dollar and cheaper oil price, earnings could bounce back.

That being said, lower earnings aren’t completely benign. Most valuation metrics indicate that US stocks are slightly overvalued by historical standards, meaning that either earnings growth needs to accelerate or that future stock market returns will be lower than average. The earnings slowdown suggests that the second outcome may be more likely, and investors should reduce their expectations about the medium-term returns that they’re likely to get from US stocks.