Global economy may have to settle for a slower pace

WASHINGTON: The new normal for the world economy may be arriving as the US, Europe and China all decelerate simultaneously. After policy stimulus and inventory-rebuilding pulled the major economies out of recession with 5% growth in the first quarter, they are slouching toward a weaker expansion, even as they show signs of dodging a double-dip. Global growth may average 3.25% to 3.5% in the next three to five years, well below the 4.7% pace of the five years leading up to the 2008 slump, estimates Stephen Roach, non-executive chairman of Morgan Stanley Asia.

Behind the deceleration in the long-run noninflationary growth rate: consumer retrenchment in the US and fiscal consolidation in Europe, as well as weaker bank lending and employment in both. Chinese growth also may ebb as the world’s most populous country reorients its economy away from manufacturing and exports. “Post-crisis headwinds will restrain trend growth in world gross domestic product by 1 to 1.5 percentage points,” said New York-based Roach, who also teaches at Yale University.

The new normal means investors may have to accept lower returns and greater volatility in their portfolios, according to Mohamed El-Erian, chief executive officer of Pacific Investment Management Co in Newport Beach, California, manager of the world’s biggest bond fund, who helped coin the term. “It implies a lower overall nominal return” than the historical average of 6% to 8%, he said.

The fair value of the Standard & Poor’s 500 Index is 900, according to Jeremy Grantham, chief investment strategist in Boston at Grantham Mayo Van Otterloo & Co. That’s 22.5% below the July 23 close of 1,102.66 at 4 pm in New York. Grantham says developed economies will be “lucky” to grow 2% annually for the next seven years, and he favours stocks of companies with high, stable returns and less debt.

“In the end, by hook or by crook, debt levels must be lowered at every level” in the industrial world, he wrote in his quarterly newsletter released July 19 on the company’s website. Jim O’Neill, chief global economist at Goldman Sachs Group, isn’t so gloomy. While acknowledging the economic cycle “is clearly slowing,” he estimates the global growth trend is about 4% and may be rising, driven by emerging markets.

“Half the world’s population doesn’t wake up and say ‘credit crisis’ before breakfast,” said the London-based O’Neill, who derived the term BRICs to describe the rising power of Brazil, Russia, India and China. In a sign of strength, data last week showed the UK economy expanded 1.1% in the second quarter, the fastest pace in four years and almost twice economists’ forecasts.

German business confidence unexpectedly surged to a three-year high this month, according to the Ifo institute in Munich. Its index based on a survey of 7,000 executives jumped to 106.2 from 101.8 in June, the biggest gain since 1990. “Given how Germany is geared towards the global economy, this indicator should have fallen rather than risen and, if anything, points to a soft landing in the global economy rather than a double-dip scenario,” said Violante di Canossa, an economist at Credit Suisse Group.

Investors may need to manage risk by going beyond traditional diversification strategies of splitting portfolios between stocks and bonds, El-Erian said in an e-mail. That might involve the use of hedges against outsized market declines and other portfolio-insurance strategies. Pimco is planning a fund that will offer protection against market drops of more than 15%. The slowdown in the recovery is evident in recent economic reports, with a UBS index showing data worldwide in July increasingly falling short of forecasts for a second month, the worst two-month period since the recession began in 2008.

“There will be possibly a period of slower growth beginning in end markets later this year,” George Buckley, chief executive officer of 3M, told analysts on July 22. “This isn’t a double-dip per se,” he added. “It’s just a soft spot and very normal as economic growth takes a breather for a while and adjusts to new circumstances.” The St Paul, Minnesota-based company is considered an economic bellwether because its product range spans the automotive, consumer and health-care markets.