Many investors are eagerly awaiting the latest policy statement from the Federal Reserve, due out Wednesday, as they remain highly focused on what will happen to the economy and markets when the Fed eventually pulls back its asset-purchase programs.
These concerns are certainly valid as US economic data continues to be mixed. Last week, while reports on new home sales and durable goods orders were both solid, an important leading indicator — the Chicago Fed National Activity Index (CFNAI) — came in weaker than expected and negative for a fourth month in a row.
In fact, the CFNAI, a forward-looking metric that has historically done a good job of forecasting future growth, suggested that US growth, after a weak first quarter and what looks to be an even weaker second quarter, is off to a sluggish start in the third quarter, and corporate earnings estimates for the third and fourth quarters may need to be scaled back.
However, as I write in my new weekly commentary piece, while earnings downgrades associated with disappointing US growth remain a risk for US stocks, market events last week – particularly in Europe and Japan — provided some improving news for global growth.
Next page: Global growth
- Europe: The latest Spanish labor market and German business data suggested the region is stabilizing. Should this trend continue, it would mean that continental Europe, which represents roughly a fifth of global gross domestic product (GDP), will stop being a drag on the global economy.
- Japan: Last week, Japan reported modest inflation, a good sign that economic stimulus efforts by the Japanese government and Bank of Japan (BOJ) may be starting to work. Faster growth in Japan would have a real impact on the global economy as Japan is the world’s third largest economy.
In addition, the extraordinary efforts of the BOJ should help mitigate the potential loss of monetary liquidity that could come about if, and when, the Fed pulls back on its bond purchases. The BOJ is currently purchasing seven trillion yen a month worth of bonds. To put that number in perspective, relative to the size of the Japanese economy, these purchases are roughly three times the size of the Fed’s monthly purchases. Additionally, while the Fed is likely to slowly taper (or slow the rate of purchases) over the coming months, the BOJ has indicated that it intends to keep up its bond-buying program for at least another two years.
For investors, there are two main implications of this global growth support coming from abroad.
- Consider International Stocks. Those investors dramatically underweight international equities may want to consider raising their allocation to broad international benchmarks.
- Overweight US Mega Caps. If we do see improving growth from the rest of the -world, large- and mega-cap US companies – particularly those in the US technology sector – are best positioned to benefit as they derive a significant portion of their revenue from overseas. Such stocks are accessible through funds like the iShares Global 100 ETF (IOO).
Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist.