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No Spring Thaw for Global Markets, Amid Slower Growth, Higher Risks

The likelihood of a world recession has grown, but plenty of signs still point to global economic growth—if at a much more subdued pace. Morgan Stanley’s global economics and strategy teams update their strategic 12-month outlook.

After taking some hard knocks early in 2016, the world economy looks shaky. In a set of new reports, Morgan Stanley’s global economics team now assigns a 30% probability to the risk of a global recession this year.

That’s the bad news.

The relatively good news: A number of countervailing forces—strong consumer spending, low oil prices and expansionary monetary policy—will likely prevail, propelling global growth to 3% for the year. That’s still down 0.3 percentage point from their forecast last November, and would mark a drop from 3.1% growth achieved in 2015.

Weak growth will mean more accommodative monetary policy from major central banks, says Elga Bartsch, co-head of global economics. Markets and investors can expect more aggressive forays into negative interest rate territory from Europe and Japan’s central bankers. Meanwhile, the Federal Reserve may only have enough leeway to raise its key interest rate once this year, says Ellen Zentner, chief US economist. She expects that, like last year, the Fed will not act until the very end of 2016.

China’s growth momentum also is expected to continue slowing. Disinflationary pressures and a rising debt burden for its industrial corporate sector will likely cut into wage growth, which is expected to slow consumption growth, says Chetan Ahya, co-head of global economics. 

Playing Defense

What does that mean for investors? For Morgan Stanley’s chief cross-asset strategist, Andrew Sheets, the best offense in 2016 is to play good defense. “Weaker growth forecasts and rising political risk lead us to close our positive tactical stance and lower exposure in global equities, and to moderate our EU credit weight after the sharp European Central Bank driven rally. We add to cash, US Treasuries and Japanese government bonds, given significant changes to our monetary policy and rate forecasts,” Sheets says, adding: “We remain bullish on the US dollar and Japanese yen and bearish on other Asian currencies.”

Morgan Stanley’s strategists have turned more cautious on equities. They’ve cut their 12-month price targets and see a negative bull/bear return skew across markets. Yet, they also have some preferences: US equities most, Europe and emerging-market equities least. It’s also a good time to get picky, as selection of quality and value become increasingly more important, as broader benchmarks either retreat or more face volatility.

Sheets believes that credit markets, i.e., corporate bonds, may be best positioned to deliver “reasonable risk-adjusted returns in a slow growth backdrop.” His preference for outperformance with lower volatility: US investment grade paper.

Other Highlights

  • Downward revisions of 0.3 and 0.4 percentage point for developed and emerging market growth, respectively;
  • 0.2-0.3 percentage point growth cuts for the US (1.7%), euro area (1.5%) and UK (1.7%), and twice that for Japan, to 0.6% growth for the year, from 1.2% previously;
  • China and India growth estimates fall by 0.2 and 0.4 percentage point, respectively, to 6.5% and 7.5%;
  • Severer contractions expected for Brazil (-4.3% vs. -3%) and Russia (-2.1% vs. -0.8%);
  • Lowflation and deflationary pressure will continue, with most developed market central banks unable to meet their inflationary targets before the end of 2017.

The key risks that could derail growth and tip the world economy into recession? Failed policy and politics: namely, if developed market central banks, such as the Fed, ECB or BoJ, lose control of domestic financial conditions, or emerging market policy makers—read China—can’t stem international capital flows; plus, the broad range of political and geopolitical risks, notably the Middle East conflict, the refugee crisis in Europe and a number of local situations, such as the UK’s coming “Brexit” referendum on whether to exit the EU, Brazil’s ongoing corruption scandal, or the US presidential election in November.

For more Morgan Stanley Research on the macro and strategy outlook for 2016, ask your Morgan Stanley representative or Financial Advisor for the full reports, “Global Macro Outlook: Lower Growth, Higher Risks” and “Spring Global Strategy Outlook: Playing Good Defense” (both published Mar 13, 2016). Plus, more Ideas.

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