Economy and stock market move in cycles. Growth is never linear; it is always cyclical. The duration of the cycles, however, varies. Some cycles are short, others medium or long. The cyclicality is high in developed countries where there are periodic ups and downs. A recession once in 8 to 10 years is par for the course in the developed economies. But emerging economies like India rarely tip into recession; but there can be sharp growth slowdowns. Recession or sharp slowdown in the developed countries like the US or the Euro Zone can impact global growth, thereby adversely affecting growth in the emerging markets also. This will impact stock markets, too. Therefore, it is important to examine the trends in the global economic scenario and their implications for stock markets.
Global economy resilient despite crisis
The global economy has been plagued by multiple crises during the last four years. The Covid-19 pandemic, the Russian attack on Ukraine, the synchronized monetary tightening by the central banks of the world and the Israel-Gaza conflict…all happening within a short span of four years turned out to be a time of severe stress for the global economy. But the global economy has been surprisingly resilient. It has smartly rebounded from the massive contraction of 2020 and inflation has been largely tamed. Even though the wars in Ukraine and Gaza continue, that is not impacting global economic growth and fears of a food and energy crisis have almost disappeared.
Global growth stabilizes
The near consensus among economists was that the US would tip into recession sometime in 2023 pulling global growth down. It was feared that the Euro Zone also may tip into recession. Recession in the US and Euro Zone was expected to impact global growth. But the global economy surprised with remarkable resilience thanks to the impressive growth in the US. Global growth bottomed out at 2.3 percent after inflation peaked at 9.4 percent in mid 2022. IMF’s projection of 2.9 percent global growth in 2023 proved to be too pessimistic. Global growth has bounced back by an estimated 3.2 percent in 2023 and IMF’s growth projection for both 2024 and 2025 is 3.2 percent. Barring unforeseen circumstances, this appears to be the likely scenario.
Inflation tamed
Inflation surged in 2022 in the developed countries taking their central banks by surprise. By mid 2022 CPI inflation touched 9.4 percent in the US and crossed 10 percent in the Euro Zone. The Fed and the ECB were forced to resort to ultra-tight monetary policy to rein-in inflation. The hawkish monetary policy has paid off with inflation cooling off even though US inflation continues to be higher than the Fed’s long-term inflation target of 2 percent. Having put the inflation genie back into the bottle, the ECB has started moving into a dovish monetary stance with a 25 bp rate cut in May this year. The Fed is expected to cut the Fed fund rate at least once in 2024 and four times in 2025. With inflation coming under control and growth remaining resilient, prospects of a soft landing for the US economy appear bright.
The slump in global trade also appears to be over. The IMF’s projection is smart recovery in global merchandise trade from 1.2 percent contraction in 2023 to growth of 2.5 percent in 2024 and 3.3 percent in 2025. This expected recovery in global trade, too, can aid growth, particularly for developing economies. This emerging scenario is favorable for equity markets. In fact, the equity markets have largely discounted this optimistic scenario pushing the major global stock indices to record highs.
A trade war in the offing?
What are the risks to this optimistic scenario? Many developments – presently known and unknown – can throw a spanner in the works. Continuation of the Ukraine war is a matter of concern. The Israel-Gaza conflict may aggravate into a regional conflict triggering an energy crisis.
The biggest threat appears to be a potential trade war between US and China impacting global trade and thereby, global growth. China has slowed down. Unfavorable demographics and the crisis in the property market will continue to weigh on Chinese growth. Faced with sluggish domestic demand, China will have to boost its exports. This will face retaliation from the developed world. The European Union has recently increased the tariffs on Chinese electric vehicle exports up to 38 percent. US, too, will raise tariffs on Chinese exports. Things are likely to take a turn for the worse under a Trump presidency, which cannot be ruled out now, despite Mr. Trump’s indictment by the court recently. This possibility of a global trade war is the biggest known threat to the global economy going forward.
