Don’t rule out a global economic recession in 2015. Several global events like China’s real estate market, lower oil prices, the threat of deflation in Europe, and risks in emerging markets could severely slow the pace of the global economy and any potential growth.
Chinese Housing Market to Trigger Global Economic Recession?
A major correction in Chinese home prices is one of the biggest risks to a global economic recession in 2015. But with the Shanghai Composite Index up 90% since the start of 2014, you’d be forgiven for not knowing there is yet another pending crisis coming out of China. And really, why should we care when the threat of a bursting housing bubble isn’t even on the radar in China?
Chart courtesy of StockCharts.com
Because China is the second-largest economy globally, its housing market, 25% of China’s gross domestic product (GDP), is showing some worrying sings.
A report for the month of February highlighted that home prices in 61 out of the 70 major city centers in China experienced price declines. (Source: National Bureau of Statistics of China, March 18, 2015.) Prices in tier three and four cities are falling; so are property values in major city centers like Shanghai and Beijing. But investments by overleveraged developers show no signs of slowing, as real estate investment increased by 11% year-over-year in 2014. (Source: National Bureau of Statistics of China, February 26, 2015.)
China’s government will step in with measures like lowering downpayment requirements, continued interest rate cuts, and even the purchasing of private real estate to convert into public housing. Whether these measures will work is yet to be seen.
Many bulls point to the fact that the migration of rural workers to the cities will support housing demand and perpetually increase prices. In my eyes, this becomes less relevant as the economy slows in aggregate.
My guess is that China’s growth decline and transition to a consumption-lead economy will be bumpy and slow. How bumpy depends on how the government will juggle an oversupplied housing market, high debt levels, and the need to lower interest rates to boost other parts of the economy.
An unexpected collapse in China’s real estate market could lead to a severe economic recession in 2015, sending ripples across the globe.
Oil Prices Indicating Global Slowdown Inevitable?
Historically, large oil price declines (40%+) have, in some cases, been followed by a recession. For example, just look back to December 2008, when oil prices bottomed at $35.00 a barrel, while just a few months before that, a barrel of oil cost $100.00.
Chart courtesy of StockCharts.com
The problem this time around is that, yes, to a large extent, the decline in oil is driven by excess supply, but demand is also at fault and it shouldn’t go unnoticed. In 2014, U.S. oil production grew 15% year-over-year and is expected to add another six percent in 2015. On the demand side of the equation, many economies are struggling to muster any real economic growth. The eurozone only emerged from negative growth in 2014, and China is cooling to an expected seven-percent expansion, its slowest pace in many years.
Overall, lower oil is seen as a net benefit to the global economy in the form of reduced energy costs. It can also be thought of as a wealth transfer from exporters with high incomes and savings (think Exxon Mobil) to consumers (the underemployed wage earner).
Another transfer at play is from exporters to importers of energy. Emerging markets like Brazil and Russia, which are already suffering from high inflation and low growth, are now much more likely to experience prolonged recessions due to a drop in the price of their primary export.
Not only does the lower price of oil elevate recessionary risk in many commodity-sensitive emerging markets, but it also produces unintended consequences.
Let me explain…
Deflation in Europe
A rising tide is said to lift all boats, but what about Europe?
In January of 2015, the European Central Bank (ECB) committed to an unprecedented amount of monetary stimulus. The ECB agreed to infuse the European economy with one trillion euros. This will come in the form of 60 billion euros in monthly asset purchases running through to September 2016 at earliest. The idea is to revive demand and increase credit growth in a stalling economy. The eurozone grew just shy of one percent in 2014 and was in recession for most of 2012 and 2013.
European economists are worried, and rightly so, that weak demand throughout the region could lead to deflation. The problem is that expectations of lower prices tomorrow lead to less consumption today. Everything is expected to decline in value, including the incomes of consumers and government revenues. At the same time, central banks are helpless, because in today’s environment, interest rates around the world are already zero-bound. There’s neither room for further stimulus nor room to boost expectations.
If the ECB’s measures fail to revive the economy—targets of 1.25% to 1.75% growth in 2015—then few alternatives will be left. The threat of deflation in the European Union, the largest economy globally, serves as one of the major catalysts for economic recession in 2015.
A Strong U.S. Dollar and Emerging Markets
In stark contrast to Europe, the U.S. economy is expected to muster 2.7% growth in economic output during 2015. Despite inflation in the U.S. sitting below one percent (half the projected target), the Federal Reserve is expected to raise interest rates in the latter half of this year. A rise in interest costs is manageable for the strongest economy globally, but it could severely damage emerging markets and lead to a global economic crisis in 2015.
The move by the Fed is likely to spark volatility, just as it has been doing since the spring of 2013. On May 22, 2013, Ben Bernanke, the former chairman of the Federal Reserve, signaled that the Fed would start scaling bank its bond purchases, reducing the stimulus that had been in place since 2009. This move sent emerging markets and their currencies tumbling. The chart below plots a fund, which tracks the performance of 15 currencies, including the yuan, the Mexican peso, the Brazilian real, and the Turkish lira.
Chart courtesy of StockCharts.com
The downward move in the currency markets was notable. Many emerging markets weren’t ready to withstand the effects of rising U.S. interest rates and, consequently, a stronger U.S. dollar. A relatively cheaper currency can boost exports for emerging markets like China and South Korea. That’s not a problem. The real issue comes when countries with high amounts of external U.S. dollar debt are forced to repay with a now-devalued local currency. Another negative consequence is when an already stagnant economy like Brazil is forced to raise interest rates to keep its currency from plummeting.
Emerging markets pose a serious recessionary risk for 2015. Countries that cannot benefit from a higher dollar through their now-cheaper exports and those that have high debt levels with mounting budget deficits will suffer. Domestic crises in vulnerable nations like Hungary, India, and Brazil significantly raise the risks of a global recession in 2015.
Economic Recession in 2015
The big risk is that investors are being forced into stocks, when recessionary risks are rising. Aside from focusing on the valuation of the S&P 500, which stands at pre-Great Recession highs, I would also suggest keeping an eye on global risks.
An important closing point to consider is that more than 20 central banks have lowered interest rates since December 2014. This literally includes every major economic power, including India, China, Canada, and Sweden, which are struggling to revive demand. When the focus shifts to the lackluster performance of global economies, the recessionary risks outlined here will be of even greater importance to market performance.