Caution: Slow growth ahead

The past five years have been an incredibly difficult time for both the global economy and investors. Many investors and analysts assumed that given the amount of time from the initial down swing of the economy that the GDP growth would, by now, have returned to its historical average.  

Over the past couple years a conflicting view has been introduced called the “new normal”. The term was meant to convey that the days of high growth of the 1980s and 1990s will not be seen again for some time, and that most likely the economy will muddle its way through for the foreseeable future. But, many investors are asking themselves what does that growth outlook realistically look like and when will the economy get back to the good times? 


Where we were 

In order to assess where we are going we need to take a step back and look at the most recent past. In 2009, GDP in the United States and globally fell drastically. In the US, real GDP contracted by 3.5 per cent whereas the world’s GDP declined by 2.4 per cent.  

In 2010, growth in the US and global economic markets increased significantly with a growth rate of 3 per cent and 4.1 per cent respectively. Growth like that was very positive for the global equity markets as reflected by the 12 per cent price appreciation in the S&P 500.  

Then in 2011, the story started to change a bit and it looked like the US economy was approaching stall speed with a GDP growth rate of 1.7 per cent. This was also reflected in the stock market with the S&P 500 providing a 0 per cent return for the year.  

In contrast, the global growth did much better at 2.9 per cent. This was primarily due to emerging markets, such as China and India, posting GDP growth rates in excess of 8 per cent. Although without the developed economies growing at faster rates, it was a sure sign there could be some slowing in the emerging market economies.  


Where we are now 

GDP growth in the first quarter of 2012 in the US was disappointing at 1.9 per cent. On a global basis GDP has also slightly slowed to 2.4 per cent. Again the average was helped in large part by growth in the emerging market economies.  

Europe is a much different story with GDP contracting by 0.1 per cent in the first quarter of 2012. Economists estimate that given all the turmoil, the economy in Europe does not appear to be improving any time soon. What many worry about is the collateral damage that slow growth in Europe can cause.  

The European Union is the largest economy in the world and with the issues in Greece, Spain, Portugal and Italy there is concern that the European Monetary Union will break up in a very unpleasant way. Even the rosiest estimates of growth are not very good.  


Where are we going? 

Consensus estimate is that there will be very slow positive growth for the next few years in the US and globally. Although the view of growth in Europe is very different with estimates that the European Union will contract its GDP by -0.5 per cent for the second quarter of 2012 and -0.6 per cent for the third quarter of 2012. Consensus estimate is that there will not be any real growth above 1 per cent until the third quarter of 2013.  


What does all this mean? 

Over the past two years many economists have spoken and published their thoughts on the global economy and about the risks of stagnating growth. One economist put it very well.  

Austan Goolsbee, a former professor at the University of Chicago’s Booth School of Business and later a chairman of the President’s Council of Economic Advisors, made some interesting comments when interviewed on 13 May on CNBC’s The Wall Street Journal Report. He indicated that with 2 per cent growth in the economy it would essentially keep the economy at where it currently is. It would cause no real growth in job creation which meant there would be no meaningful reduction in the unemployment rate.  

This is partly due to the increase in population growth. Without growth rates of at least 3 per cent, it would not be realistic to see unemployment rates falling back to historical average of around 5-6 per cent within the next five years. 

With high unemployment and low growth, stocks will most likely have lower returns over the next five years. This probably means returns in the equity markets averaging around 6-8 per cent but with wide volatility from one year to the next.  

Just as depressing is the returns provided by fixed income investments. The weak past growth also means that interest rates have been lowered to historic levels to encourage borrowing. As an investor in fixed income securities, average returns for high quality, short-mid duration fixed income bonds should be from 1-3 per cent per year for the next five years.  

In times like these investors are less concerned about the return on their capital than the return of their capital. Tread lightly. 


”Disclaimer: The views expressed are the opinions of the writer and whilst believed reliable may differ from the views of Butterfield Bank (Cayman) Limited. The Bank accepts no liability for errors or actions taken on the basis of this information.