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What Do China, Egypt and Your Portfolio Have in Common?

This week the IMF released revised, mostly lower, global growth forecasts for 2013. The key takeaway: continued slow economic growth across the globe. The global economy is now projected to grow at a rate of 3.1%, equal to last year’s tepid growth rate. More specifically, the IMF forecasts a second consecutive year of GDP contraction across the Euro Area, a meager 1.7% growth rate in the U.S., and moderated emerging market growth at 5.0%, led by downward revisions to Chinese growth projections. Reports of continued slowdown in manufacturing and exports in China, along with the government’s visible efforts to reign in excess credit, have increased downward pressure across emerging markets. If all of this news were not enough to make investors nervous, political turmoil in Egypt has sparked fears of an oil supply shock, pushing crude oil prices to a 14-month high.

What do these negative headlines really mean for investors? The good news is that the headlines are not as bad as they seem, or at least not for your portfolio.

Global Economy vs. Stock Market

It is important to remember that the relationship between economic growth and stock market returns is not straightforward. While economic growth is an influential factor for the stock market, (the stronger aggregate demand and better access to credit that accompany a healthy economy are certainly favorable conditions for businesses), many other factors are at work, too. One only needs to consider last year’s markets to understand that economic growth is not predictive of market performance. In 2012, the S&P 500 gained an impressive 13.4% against a fairly anemic 2.2% economic growth rate. Conversely, the Chinese economy grew at a stronger, albeit contracted rate of 7.8%, while the Shanghai Composite Index increased only 3.2%. The point is that investors should not assume that the prospect of lower economic growth will directly translate into lower returns in their equity portfolios.

The Truth about China

While China takes up a lot of headline space, we believe that fears of a more protracted slowdown and a potential banking crisis in the country are likely greater than the actual impact they will have on a well-diversified investment portfolio. Negative impacts of a “hard landing” scenario, the likelihood of which seems to be increasing once again for the world’s biggest growth engine, will indeed be felt in other markets. For example, commodity exporters such as Brazil and South Africa would undoubtedly take a hit from reduced Chinese demand. However, in the event of a credit crisis, we expect it to be largely contained within Chinese borders and to have nowhere close to the level of global impact we have seen with the U.S. and European financial crises.

Egypt’s Impact

It is unclear how the political situation in Egypt will unfold. The recent spike in crude prices reflects fears that a supply shock could occur should activity through the Suez Canal be shut down. The truth is that this scenario is highly unlikely. Therefore, we could see oil prices come back down fairly quickly, but prices may also spike again if political uncertainty and unrest persist – we just do not know. Investors with commodities exposure should expect that this portion of their portfolios may experience an increase in volatility until some of the current uncertainty is dispelled. What is important to remember is that these headlines create a lot of noise in the markets and do not necessarily reflect actual supply and demand dynamics. Therefore, it would be wise not to allow short term price fluctuations driven by sensational headlines to influence buy/sell decisions.

A well-diversified portfolio constructed to accommodate your individual risk tolerance should be able to weather some short term volatility as markets react to news headlines. We remain focused on strategies that position investors to generate balanced, lower risk, long term growth while minimizing the costs associated with excessive trading and layered fee structures.

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