Is the Global Economy Heading into a Recession?

Massive capital flight racks the equities markets!

Following 3 months of strong and steady growth, the Dow Jones Industrial Average tanked on October 9, 2014. Fears about the performance of the global economy have been brought to bear on US markets, and investors are having none of it. The DJIA plummeted 334 points on the day, as frantic selling gripped Wall Street. This is in sharp contrast to the blue-chip index which soared 275 points on October 8, 2014. Many analysts have been cautiously optimistic since 2011, when Wall Street’s Bull Run began. Fears of a market correction, or worse yet a correction that dovetails with global economic sentiment, are now a reality. For several months, US traders have nervously been watching lacklustre or negative growth in Europe, Japan, Russia and across Latin America. The sum total of downwardly revised growth prospects for these regions is now affecting US markets too.

Volatility Returns to the Global Financial Markets

Since 2011, US investors have enjoyed relative calm as the NASDAQ and Dow Jones Industrial Average generated solid and consistent growth. Large fluctuations in market performance have for the most part been a rarity, but now they are a reality that traders have to contend with. The term that is used to describe a re-evaluation of stock market prices is often called a correction. More specifically, this refers to a 10% downward revision in the price of stocks from a recent high. While investors may not be ready for these erratic market movements, the correction is long overdue. Volatility typically scares off smaller investors who are worried about their retirement nest egg. But it should be borne in mind that growth, profitability and capitalisation in the stock market are long-term endeavours. In spite of the recent volatility, the market surged 30% in 2013 and the S&P 500 Index is already up over four percentage points for 2014.

International Growth Rates Revised Downwards

The selloffs continued unabated during the second week of October 2014. A big part of the concern relates to the poor performance of the European economy. Allied with that are sub-optimal earnings reports in the US. The NASDAQ composite index, the S&P 500 Index and the Dow Jones Industrial Average all suffered steep declines. The Eurozone’s best performing economy – Germany – has had its GDP revised downwards, and the IMF expects growth rates to be less than beginning of the year estimates. According to the International Monetary Fund the global economic growth rate for 2014/2015 has been stymied. This is largely due to poor performance across Europe, South America and Japan. Back in July 2014, the IMF forecast a global growth rate of 3.4%, but this has been decreased to 3.3% for 2014. For 2015, the growth rate is expected to be 3.8% – this is still lower than prior estimates.

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When it comes to the US economy, there is more optimism. Forecasts for 2014 GDP growth are 2.2%, sharply up from 1.7% earlier on. The expected growth rate for the US in 2015 remains unchanged at 3.1%. The general consensus among Banc De Binary analysts is that there is an uneven and weak recovery taking place. Investors across the US are now pouring their funds into government bonds, and other safe haven investments like gold. Wall Street is gearing up for Q3 earnings and various policy meetings by the Federal Reserve Bank. The eponymous Fear Gauge (which measures investor fears) spiked to its highest level in seven months by Tuesday, 9 October. On the commodities front, oil prices have been falling, owing to excess supply and recessionary fears. The price of Brent oil dipped beneath $90 p/barrel for the first time since 2012, with prices down by over 20% since June 2014. A weaker US dollar also depresses oil prices further, but the major concern is depressed demand across Europe.

The Impact of Interest Rates and Global Growth

Europe and the US now sport interest rates that are at historic lows. One of the problems with abnormally low interest rates is that any upward revision can have profound effects on investor sentiment. If interest rates rise, equities fall since investors would derive more benefit from long-term securities like Treasury Notes and Certificates of Deposit. This is the opportunity cost related to interest rates. Much of 2014 was focused on Ukraine crisis, growing tensions between Russia and the US and the turmoil across the Middle East. Massive capital flight from Russia has ground to that country's economy to a standstill, and 2015 doesn't look much rosier. The Eurozone countries will likely enjoy an anaemic growth rate of 0.8% in 2014, 0.3% down from the July forecast. Estimates for growth in 2015 have likewise been revised downwards from 1.5% to 1.3%.
However, the International Monetary Fund is sticking to its position that the world's foremost economies – Europe, the United States and Japan – maintain historically low interest rates to increase borrowing and to increase the velocity of money flow through the global economy. This is seen as the only way to stop deflationary pressures, to increase spending and kickstart regional economies. In recent months, the European Central Bank under the auspices of board and Mario Draghi considered implementing quantitative easing policies. The IMF believes that the European Central Bank should consider purchasing government bonds to stimulate economic activity. The IMFs advice for the US is to hold off on tax hikes until mid-2015. Projects that governments can increase investment in are those relating to job training, infrastructure expenditure and education.

The Japanese Economy in Dire Straits

A big part of the reason why Japan is struggling is the recently introduced sales tax increase. The consumption tax was raised in April 2014 from 5% to 8%, and now stands at 10%. Japanese Prime Minister Shinzo Abe introduced the tax hikes in an attempt to pay for the increasing costs of social welfare for Japanese retirees. Japan's future economic growth is in jeopardy as the ratio of young people to elderly people is shrinking. These tax hikes have plunged the Japanese economy into recession and the effects of these tax hikes are coming home to roost. Deflation is a very real concern in Japan, as well as across the Eurozone.

There's been very little positive data about the ramifications of tax hikes in Japan, with most analysts reporting unfavourably on it. On Tuesday, 8 October, the Bank of Japan (BOJ) acknowledged that industrial production was faltering since the sales tax was increased. This opinion has been circulating among private economists for months now. The general consensus is that Japan is undergoing a recession and this is weighing heavily on US stocks. The government's de facto opinion of the economy is that it is presently in a turning point for a downturn. Like Europe, the US, and the UK, the Bank of Japan Governor is targeting a 2% inflation rate.

Written By: Banc De Binary