As a former economist, I’ve always loved following the macro themes when looking for breakaway stocks and investments. Find the big picture forces like rates, currency impact and trade that are moving markets and you’ve got a huge head start on where an investment is going.
Over the last several years, it’s these economic forces that have been leading the markets.
Consumer staples and shares of utility companies have easily beaten the S&P 500 over the last year, jumping 12.6% and 17.2% as the Fed held off on raising rates. The flip side has been the weakness in financials as the net interest spread tightened, making it difficult for banks to make any money.
As we come in to what could be the later innings of the business cycle, it won’t take much to tip the markets back into freefall.
The World Bank expects the global economy to grow just 2.4% this year, the same rate of growth booked last year, and next year is only expected to improve to 2.8% growth. Developed markets are expected to inch along at just 1.9% growth next year, less than half the 4.9% growth expected in emerging markets.
On miserably low expectations, it won’t take much to derail the global economy into the next recession.
In fact, there are five major potential economic shocks I’m following. Each of these could mean disaster for some markets, while others could escape relatively unfazed.
I’ve found two markets that could actually benefit from some of these likely shocks… and they are two of the last markets you would expect.
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Five Economic Shocks That Could Turn The Markets
The economic research team at Deutsche Bank AG (USA) (DB) looked at the effect of five major economic shocks awaiting stocks and how the economies of 25 countries would react.
None of the economic shocks are black swan events. Some are already building momentum while others could very likely hit the markets over the next year. The team measured the impact of each shock on the real GDP level over two years in each country.
• Impact of a 0.25% Fed rate increase
• Impact of a 10% increase in oil prices
• Impact of global selloff in stocks, measured by a decline of one standard deviation
• Impact of one percent decline in China GDP growth
• Impact of 10% depreciation in China’s Yuan
A 0.25% increase in the Fed Funds Rate is the most likely to occur, and could decrease the global economy by 0.4% with the U.S. economy seeing a slightly larger hit. Among the cohort, seven countries could actually see an increase in GDP growth, including Saudi Arabia, Chile, Mexico, Norway and India.
While a 10% increase in the price of oil would be a slight positive for global growth, the United States could see growth decrease over the two-year period due to net fuel consumption. Ten countries could see net gains to GDP on an oil price spike, including Mexico, India, South Africa and Turkey.
A global selloff in stocks would be a negative for growth in every country except India, leading to a 0.5% hit to overall global growth over the period. The selloff would generally affect emerging markets, as investor risk sentiment deteriorates and causes foreign investment to weaken, but the team estimated that even the U.S. economy could see a drop in GDP over the period.
A slowdown of 1% in China’s GDP growth would have about the same effect on the global GDP as a drop in equities, leading to a 0.5% hit to growth. Only India escapes, with nearly a 0.5% increase in real GDP over the subsequent two years. Mexico performs relatively well, with real GDP falling less than the average while the United States sees a GDP decline slightly greater than the average.
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A 10% depreciation in the Chinese Yuan was a negative for all but four countries: Mexico, India, Philippines and Norway. While the United States would escape the drop of about 0.4% on global GDP, it could still see GDP decline by as much as 0.25% on the depreciation.
Taking each of the economic shocks together, two countries stood out as surprisingly resilient. Both are benefiting from widespread structural reforms led by their governments, so could see strong economic growth despite external shocks.
Two Countries That Stand Out Against Potential Shocks
India has benefited from widespread reforms under Prime Minister Modi since 2014. Foreign direct investment has surged 37% since October 2014 on financial reforms in almost every sector of the economy. Inflation of 6.07% is just above the central bank’s range of 2% to 6%, but analysts see the potential for a 0.25% rate cut this year to help support growth. India was the only country to see a positive GDP impact in all five of the economic scenarios.
The iShares MSCI India ETF (INDA) holds shares of 75 companies representing 85% of the market cap on the domestic index. The fund is overweight in Information Technology (19.9%), Financials (17.5%) and Consumer Discretionary (13.8%), but gives investors exposure across all 11 sectors. Shares pay a 1.25% dividend yield and have risen 7% this year.
Structural reforms in Mexico, especially in telecom, are expected to bring investment growth, and the economy should continue to benefit on its ties to U.S. trade. The government has been one of the few in the region to cut fiscal spending on lower oil revenues, and the Central Bank recently raised rates by 0.5% to control the 2.6% inflation rate. This kind of fiscal and monetary discipline could save the country with ammunition to spare if the global economy gets shocked.
The iShares MSCI Mexico (EWW) holds shares of 62 companies that trade as ADRs and on the domestic exchange. The fund is relatively less diversified, with exposure to seven sectors and over-weights in consumer staples (27.9%) and financials (21.4%). Shares pay a 2.6% dividend yield and are down 6% for the year.
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The World Bank sees economic growth picking up in both countries next year, to 7.7% in India and 2.8% in Mexico. That’s well above the 2.2% rate expected in the United States and most of the developed world.
Both country funds trade relatively expensively against the group of emerging markets. The Mexico fund trades at 24.9 times trailing earnings, while the India fund trades at 21.7 times trailing earnings. That’s almost twice the 11.7 times multiple on the iShares MSCI Emerging Markets ETF (EEM), though it’s roughly equal with the 24.9 multiple on the S&P 500.
While the higher P/E ratios could come under pressure in an economic shock scenario, the strength in their economies should help companies drive earnings growth and support stock prices. They could be two of the only markets for safety in a coming economic storm.
Risks To Consider: While the economies of both countries may be relatively safe from shocks, stocks could still be susceptible to a drop in investor sentiment.
Action To Take: Look for protection and relative growth in two unlikely candidates Mexico and India against likely economic shocks.
Editor’s Note: Economic shocks aren’t the only thing to worry about. While Zika and Ebola steal headlines, a much more dangerous pandemic has been developing in our hospitals. The CDC barely mentions it. But a NASA scientist, a Harvard MD, and a Johns Hopkins surgeon have shown that it’s claiming more lives than strokes, Alzheimer’s, and diabetes — combined… Full story here.
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