Unpacking IMF’s 2015 Forecast

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By Joseph Cafariello

Tuesday, January 20th, 2015

The International Monetary Fund yesterday released its January 2015 report on its global growth forecast for 2015. At first glance, its tone appears to be rather negative.

The sharp fall in oil prices will spur global growth, but not enough to offset other negative factors, one of the captions in the report reads.

The major news organizations have also taken to highlighting the negatives. IMF cuts global economic-growth outlook, reads one Market Watch headline. IMF Lowers Global Growth Forecast by Most in Three Years, announced another Bloomberg caption.

At first glance, our immediate impression is that global economic conditions are worsening. But they are not. When we look at the details of the report, we realize that 2015 is still expected to see growth the whole world over for the global economy as a whole, as well as for the two sub-categories of Advanced and Developing economies.

In fact, growth in advanced economies and for the global economy overall are expected to be greater in 2015 than they were in 2014, and equally strong or better in 2016. Only in emerging markets and developing economies is growth expected to slow in 2015 as compared to 2014. Though even there growth is expected to surge upward in 2016.

Investors need not panic over yesterdays IMF report. Heres why.

2015 Growth Overview

Of the IMFs six future growth projections, all six represent growth, not shrinkage. Of the six, four are expected to grow more than the prior year, one is expected to grow the same as the prior year, and only one is expected to grow less than the prior year.

Hence, growth is accelerating in four of the six projections, while slowing in only one of the six. Now this sounds quite different than some other headlines would have us believe, doesnt it?

Here are the IMFs six projections:

2015 global economy as a whole (advanced and developing economies combined): growth is expected to accelerate from +3.3% in 2014 to +3.5% in 2015.

2016 global economy: growth is expected to accelerate from +3.5% in 2015 to +3.7% in 2016.

2015 advanced economies: growth is expected to accelerate from +1.8% in 2014 to +2.4% in 2015.

2016 advanced economies: growth is expected to remain flat from +2.4% in 2015 to +2.4% in 2016.

2015 emerging and developing economies: growth is expected to decelerate from +4.4% in 2014 to +4.3% in 2015.

2016 emerging and developing economies: growth is expected to accelerate from +4.3% in 2015 to +4.7% in 2016.

In sum we have four accelerations, one flattening, and one deceleration. But all six represent positive growth. And notice this interesting comparison as well: developing economies are expected to grow more than advanced economies in 2015 (+4.3% versus +2.4%), as well as in 2016 (+4.7% versus +2.4%).

The IMFs report doesnt seem so bad anymore, now does it?

Now that we have a clearer read on the hard cold figures, lets consider some of the IMFs reasons for arriving at those projections.

Four Key Changes Since Prior Report

The IMFs report lists four recent developments that have influenced its projections some positive, others negative:

Cheap oil positive: The tremendous plunge in oil prices from a recent high of over $107 per barrel at the end of June to below $50 a barrel currently for a drop of more than 54% in just seven months is cited by the IMF as a major contributor to global growth. Lower energy costs mean consumers will have more money left over to spend at shops, thereby stimulating the economy. Manufacturers will also be saving operating costs, which should translate into lower consumer prices, which should in turn boost sales all the more.

Divergence among major economies negative: The recovery in the United States was stronger than expected, while economic performance in all other major economiesmost notably Japanfell short of expectations, the report explained. This trend where America grew faster than expected while other major economies grew slower than expected prompted the IMF to tweak its projections, lowering its growth estimates overall as compared to its previous report back in October.

Divergence among major currencies a little positive, mostly negative: Since the IMFs October report, the U.S. dollar has appreciated some 6 percent in real effective terms the euro and the yen have depreciated by about 2 percent and 8 percent respectively, and many emerging market currencies have weakened, particularly those of commodity exporters, the report continues. This is a little positive for commodity exporting developing nations, given that their weaker currencies result in more profit from their exports. However, such gross currency depreciation the whole world over outside of the U.S. is mostly negative since it reduces foreign investment and increased the cost of imports both of which (foreign investment and imports) are sorely needed by developing nations.

Lastly, interest rates and risk spreads both negative: Rising interest rates in developing economies and falling bond yields in advanced economies have widened the risk spread. Moreover, long-term government bond yields have declined further in major advanced economies, reflecting safe haven effects and weaker activity in some, the report pin-points. The result has been the diverting of vast quantities of capital into low yielding bonds, effectively taking that money out of circulation where it is of no use to anyone, slowing the engines of many an economy.

How does the IMF weigh all of these changes together?

Developments since the release of the October [report] have conflicting implications for the growth forecasts, its report admits to the difficulty in assessing all these recent changes. On the upside, the decline in oil prices will boost global growth over the next two years or so by lifting purchasing power. Low oil prices are also expected to benefit developing governments which can now lower energy subsidies they are paying to keep their economies running, using that saved money to invest in their infrastructure, factories, banks, etc.

However, the report stirs in the negative factors, the boost from lower oil prices is expected to be more than offset by an adjustment to lower medium-term growth in most major economies other than the United States. As a result, global growth projections for 201516 have been marked down by 0.3 percent relative to the October 2014 [projections].

For those of us who are more visual learners, the IMF has drawn-up a convenient graphic to help us weigh the positives and the negatives, as shown below. Well, just one positive, really.

Investors Tread Carefully

So how are investors to respond to the IMFs report? For starters, there is no need to panic and close your investment account. Growth is still accelerating, even though the IMF did shave a little bit off of its previous growth figures. Staying invested is still the best stance.

But looking at the risks the IMF has outlined does help us better direct where our investments should be kept, at least for 2015.

For instance, the IMF expects Stagnation in Euro Area/Japan, as noted above. While buying on the dips is generally a good strategy, 2015 will likely prove to be much too soon to go bottom fishing for value stocks in Europe and Asia, especially when the IMF has repeatedly noted the U.S.s strength:

Growth in the United States rebounded ahead of expectations, the report underscored. Unemployment declined further, while inflation pressure stayed more muted Growth is projected to exceed 3 percent in 201516, with domestic demand supported by lower oil prices, more moderate fiscal adjustment, and continued support from an accommodative monetary policy stance, despite the projected gradual rise in interest rates.

In other words, dont fear any upcoming rise in interest rates, as there are plenty of positives in the U.S. economy to offset that.

Even so, there is one other very important risk factor outlined by the IMF as illustrated above — namely, Market Volatility. Fluctuations in oil prices and currency values have triggered fluctuations in commodities, bonds and equities. And those fluctuations have only just begun.

The IMF warns that there is sizable uncertainty about the oil price path in the future The boost to global demand [for oil] from lower oil prices could be greater than is currently factored into the projections Oil prices could also have overshot on the downside and could rebound earlier or more than expected.

Cheaper oil prices are gradually increasing demand, which will eventually cause the oil price to swing wildly from here. And when oil swings wildly, so do currencies, bonds and stocks especially for large oil producing and heavy oil consuming nations.

Furthermore, In global financial markets, risks related to shifts in markets and bouts of volatility are still elevated, the report cautions. Potential triggers could be surprises in activity in major economies or surprises in the path of monetary policy normalization [an earlier than expected rise in interest rates] in the United States.

In other words, the markets are as nervous and jumpy as a coffee drinker on his fifth cup of coffee. Any sudden movement could turn the whole table over, as we saw just last week when the Swiss central bank removed its currencys peg to the Euro without any warning at all.

So whats the bottom line? Remain mostly in the U.S. for 2015, using very little margin to prevent forced liquidation as market volatility rises, and always keeping some extra cash on-hand to snap up bargain prices after a sizable correction.

And one more thing read past the headlines. The IMFs report is not as bad as some are making it sound.

Joseph Cafariello

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