Global Investment Strategy

Weekly market insights and possible impacts on investors from the Wells Fargo Investment Institute Global Investment Strategy team.

January 17, 2017

Peter Donisanu, Investment Strategy Analyst

Global Economic Growth is Stabilizing—So What?

  • Recently-published economic data suggests that activity in the global economy is stabilizing.
  • In our view, stabilization in the global economy may positively influence business investment, household consumption and international trade. We believe that these factors could underpin future earnings growth and normalization in central-bank policies.

What it may mean for investors

  • Our cautiously optimistic view of global growth prospects still favors risk assets, with a balanced view towards U.S. and international markets.

Economic data published in recent months overwhelmingly suggests that growth in the global economy is stabilizing. Economic conditions in some of the hardest-hit major economies are starting to improve. Additionally, we believe that relatively healthy economies, such as that of the U.S., could see accelerating activity in the coming year.

Chart 1. Wells Fargo Investment Institute Economic Diffusion Indices Suggest Global StabilizationChart 1. Wells Fargo Investment Institute Economic Diffusion Indices Suggest Global StabilizationSource: Wells Fargo Investment Institute, Bloomberg; 1/12/17. WFII = Wells Fargo Investment Institute. Past performance is not indicative of future results.
The Wells Fargo Investment Institute (WFII) Economic Index is a composite measure of changes in a given country’s key economic metrics relative to a rolling five-year rolling lookback period. Metrics tracked include labor and productivity, trade, inflation, monetary conditions and consumer spending. A score above zero represents expansion with a score below zero represents contraction.

Indeed, our Wells Fargo Investment Institute (WFII) economic-diffusion indices suggest that trends in both developed- and emerging-market economies are strengthening. For developed economies, a rebound in activity in the U.S. (once a detractor) now leads the recovery in advanced economies (Chart 1, left clip). In emerging markets (EM), lower rates of growth in China’s economy relative to those of the past five years have acted as a drag on our broad economic-diffusion index. Stabilization in emerging-market economies becomes more evident when the effects of China’s slowdown are excluded from the index (Chart 1, right clip).

Why is Economic Stabilization Important?

In our view, stabilization in the global economy may positively influence business investment, household consumption and international trade, which could, in turn, underpin corporate-earnings growth and central-bank policy. Business leaders and households oftentimes base spending decisions (particularly on big-ticket items) on their future earning potential.

During an economic downturn, firms may put off replacing aging equipment or opening new factories, while households may delay replacing aging cars or purchasing new homes. In an environment of subdued spending, corporate earnings often decline as spending activity weakens, placing downward pricing pressure on suppliers. These developments can prompt central banks to cut key interest rates in an effort to underpin inflationary pressures, employment and economic activity.

From a textbook perspective, global equity markets—often keen to future earnings prospects of corporations—face downward pressure as investors recalibrate price expectations to lower commensurate earnings. Global bond markets also may face heightened volatility as changes in central-bank policy cause market participants to lower interest-rate expectations and demand for certain assets. We believe that signs of economic stabilization reflect a pivot point toward economic expansion from an economic downturn. During an economic recovery, firms may resume investment activities that were postponed during a downturn, while households unleash pent-up demand for big-ticket items. In an era of globalization, trade also would be expected to gain pace, supporting the recoveries of exporting economies as demand for their goods increases. All of these developments are likely to support a rise in corporate earnings.

As corporate earnings rebound, global equity-market participants may, once again, recalibrate price expectations, this time to the upside, in anticipation of higher earnings—likely supporting higher global equity prices. During an economic recovery, global fixed-income investors may yet face bond-market volatility, this time as central bankers “normalize” (raise) rates, setting market expectations for higher yields (albeit below historical averages in today’s market environment).

Positioning Your Portfolio for an Economic Stabilization

We believe that the global economy is stabilizing, in the process of reaccelerating. We expect growth to be higher in 2017 for many major economies (except that of China).1 For equities, we expect index-based equity strategies to post modest gains in the year ahead. Nevertheless, we believe that investors may be best served by being more selective in their portfolios and favoring active over passive strategies in the U.S. and in international equity markets.

We expect a rebound in economic growth and inflationary pressures in 2017 to materialize. Yet, we also believe that global central-bank policies will largely remain accommodative. We anticipate approximately two rate hikes by the Federal Reserve this year but believe that central bankers in Europe and Asia are likely to maintain accommodative policies. Nonetheless, we favor higher credit quality for fixed-income investments today, and prefer U.S. fixed-income investments over those of lower-yielding developed-market bonds abroad. For emerging-market bonds, we recommend dollar-denominated exposure that may offer the potential for more stable returns.

1 International Briefing: What to Expect from China’s GDP Report Next Week, 1/13/17.

Risk Factors

All investing involves some degree of risk, whether it is associated with market volatility, purchasing power or a specific security. Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments.

Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.

Investments in fixed-income securities are subject to interest rate and credit risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline in the bond’s price. Credit risk is the risk that an issuer will default on payments of interest and principal. High yield fixed income securities are considered speculative, involve greater risk of default, and tend to be more volatile than investment grade fixed income securities. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.

Global Investment Strategy is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company and provides investment advice to Wells Fargo Bank, N.A., Wells Fargo Advisors and other Wells Fargo affiliates. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by the Global Investment Strategy division of WFII. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

This report is not intended to be a client‐specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon.

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