A global economic slowdown: How to be prepared

The International Monetary Fund, the global entity otherwise known as the IMF, recently made an important comment: “There is concrete risk of a world economy persistently mired in sub-par growth, with unacceptably high levels of poverty and unemployment.”

Imagine that the IMF was an individual company that just reported earnings and made a similar statement. Investors would easily be able to read between the lines to see that the corporation was fearful of what would transpire in the near future without wanting to make such a statement outright.

These types of comments are normal prior to a slowing economy becoming evident to the masses. Only in this case, it’s the global economy, not a domestic one. (For related reading, see: Interpreting the Fed’s Interest Rate Statement.)

Decoding a Comment

Here’s another comment from the IMF to decipher: “Growth remains fragile and could be derailed if transitions are not successfully navigated.”

The IMF is likely hinting that central banks need to continue navigating this treacherous labyrinth of economic malaise and continue to put investors’ minds at ease. Here’s the problem. If central banks continue to implement accommodative monetary policies, then they’re doing so by adding debt to the system. Global debt is now north of $57 trillion. No economy can deliver sustainable growth when faced with excessive debts.

Once again, look at this from a single-company perspective. If a company is highly leveraged, then paying off that debt becomes a priority in order to avoid default. This means more capital is allocated to debt repayment, which takes away from fueling top-line growth via R&D and the hiring of strong workers and brilliant minds. Recently, debt has been used for share buybacks and M&A, not organic growth.

Vicious Cycle

Since top-line growth is difficult to achieve for many companies, they are focusing on the bottom line. When these companies buy back their own shares, it reduces the share count, which then increases EPS. They are also reducing headcount in order to deliver on the bottom line, which is slowly killing the consumer. Think about this. Over the past year, how many times have you read about mass layoffs? Probably at least a dozen. Over that same time frame, how many times have you read about a company hiring by the dozens, or hundreds? Probably not at all.

As layoffs continue to mount, the consumer spends less, which then forces companies to lower their prices for goods and services. Then fewer goods need to be transported and there is lower demand for commodities. This is deflation. (For related reading, see: World Bank Data for Dummies.)

This also puts the Federal Reserve in a bind. If Fed Chair Yellen opts to hike interest rates, then it will increase borrowing costs. But since this will be a minimal move, it will be more about the perception that rates could keep going higher. That’s why, if she opts to hike, you will see her accompany this move with very dovish language, stating that she will not hesitate to move back down if economic growth slows and 2% inflation isn’t sustainable. A rate hike would likely hit equities, but it’s still the right move for the long haul. The era of cheap money has created a wide gap of income inequality. Rewarding speculators while punishing workers is not how to build a sustainable economic recovery.

Economic Projections

The IMF projects real global GDP of 3.1% in 2015. That’s a possibility, but it projects real global GDP of 3.6% of 2016. Based on current economic conditions, which are likely to worsen over the next year, those numbers appear to be very ambitious. This also doesn’t take into account the situation in China, which is overbuilt and overleveraged. The one-child policy may have ended, but the impact of it is now being felt with its aging consumer population. (For more, see: What China Devaluing its Currency Means to Investors.)

Then there’s Japan and the Eurozone, both of which feature aging populations, with Japan having the oldest population in the world—that’s not good for consumer spending. And don’t forget Brazil and Russia, which will continue to suffer if China slows down. China’s GDP growth continues to slide. It will eventually bounce back, but not at any point over the next five years.

According to Moody’s, the downside risk to the global economy has grown, and the number of stable outlook countries has shrunk while the number of negative outlook countries has increased.

According to UBS, Latin American countries are expected to see economic contraction of 0.8% and 0.2% in 2015 and 2016, respectively.

Perhaps the biggest risk is that the approaching economic downturn won’t feature a Lehman event. There is no shock, which could be seen as a positive, but this danger is lurking underneath the surface and presents more risks due to an aging global population, which slows consumer spending and leads to deflation. This all happens whilst central banks reach peak liquidity, leaving no viable options to keep the mostly-artificial bull stampeding.

For disclosure purposes, I’m net short the market. I would prefer to be bullish, but economic conditions don’t allow for it. Fortunately, the day to be bullish will once again present itself, but that will likely be years down the road.

The Bottom Line

The global economy is slowing. There is no way around this. And, yes, the stock market and the economy are connected. It just takes time for the stock market to catch up to reality at times. A plunge in commodities is often the first sign of approaching deflation, which relates to weakening demand. Plan accordingly, but please do your own research prior to making any investment decisions. (For related reading, see: China’s Economic Indicators.)

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