- Macroeconomic trends are extremely important for your investing or trading returns.
- The IMF’s World Economic Outlook is a great starting point for understanding where the risks and opportunities lie.
- Long term trends show emerging markets and commodities are the place to be.
Investing is both difficult and easy. It’s difficult if you try to guess what the market’s sentiment will be next week or next month, while it’s easy if you simply look at slow moving structural macroeconomic trends. These trends are like little forces that shape the market, similar to the gravitational forces among planets in our solar system.
For example, a developing country with a growing population will offer more profitable investment opportunities than a country with a declining or stagnating population. Just compare Italy and Australia. Both countries have had a stable economic system, but the performance of their stock indexes is practically opposite.
Figure 1: The Australian population has grown 32% while the Italian population has grown only 4.7% since 1997. Source: Worldometers.
The performance of the respective stock market indexes has been similar to the respective population growth.
Figure 2: The Italian stock market index is 20% below its 1997 level while the Australian index has more than doubled. Source: Yahoo Finance.
This is just an example of how one easy-to-spot trend influences markets. More important than population growth is economic growth, but these two things usually go hand in hand. Therefore, it’s extremely important to allocate your portfolio toward assets that are backed by positive long term macroeconomic trends. If the assets are in a short-term slump due to market fears, even better, as you can buy stocks on the cheap.
In the long term, the structural macro trends always prevail. If you’re a long-term investor, you want to be positioned alongside macroeconomic tailwinds while if you’re a trader, you can minimize your risks or bet on turnarounds with the macroeconomic trends providing a margin of safety.
A great way to follow macroeconomic trends are the publications of The International Monetary Fund. In this article, we’ll analyze the IMF’s updated economic forecasts in order to point out where the best places to invest globally are based on macroeconomic trends.
World Economic Outlook, April 2017
After 6 years of slowing global economic growth, we are finally at a turning point.
Figure 3: Global economic growth is expected to reach 3.5% in 2017 and 3.6% in 2018. Source: IMF.
This is excellent news as the projections have been revised significantly upwards. From a more local perspective, economic growth is expected to be slightly higher in the U.S., Europe, and Japan, while Latin America and the Middle East are still expected to suffer from lower oil prices. It seems that both China and Russia are bottoming out.
What’s important for investors is to look at economic growth rates. With an investment that offers the same valuation or dividend yield, I would always choose the one in an economy with better economic growth prospects.
Figure 4: Global economic growth per country. Source: IMF.
Among the advanced economies, the U.S. is showing good economic growth numbers however, the market is already priced to perfection and under the heavy influence of passive investing which will lead toward a market crash as soon as the same people investing blindly in index funds understand the extreme valuations they are paying and panic in a bear market.
Two developed countries that show interesting growth developments are Canada and Spain. Canada has a cheaper market compared to the U.S., and a weaker currency where there is a big chance for a currency reversal which should give better long term returns to U.S. investors. With Spain, it looks like the country is successfully coming out of its real estate crisis and high unemployment levels. It could be an interesting place to look for investments, but always keep a margin of safety as the European house of cards and the Euro could crash anytime.
Emerging Markets Are The Place To Be
Emerging markets are where the fun starts. Expected growth rates are above 4% in general, and above 6% for China and India. The average forecasted growth for Indonesia, Malaysia, Philippines, Thailand, and Vietnam are also around 5%.
The Indian stock market is relatively fairly priced for such growth rates with a price to earnings (P/E) ratio of 25. Indonesia isn’t far behind with a P/E ratio of 21, the Philippines with 19, and Malaysia with 18.8. P/E ratios go down all the way to 11 for Turkey, or 7.6 for China. Such low P/E ratios would be rational if there was a depression in China or Turkey, but given the economic growth those countries are experiencing, it just shows the market’s herd mentality and how passive investing is allocating capital in the worst possible way.
Trend In Commodities
Commodities have also recovered from their 2016 slump. However, commodity prices are still relatively below their long-term trends.
Figure 5: Commodities are still cheap. Source: IMF.
Alongside economic growth and with a good analysis of demand and supply trends for individual commodities, it’s relatively easy to see where average prices will be in the medium term, i.e. three to five years. However, for investing in commodities and related stocks, you have to accept the volatility inherent to those markets. Energy prices have increased 21.1% since August 2016, and metals 23.6%, while food prices increased only 4.6%. Depending on the metal or food, there are some commodities that still have much more space to run while some, like iron ore, have shown that you can’t fight long term structural trends.
Figure 6: There is simply too much iron ore on earth for sustainable higher prices. Source: Trading Economics.
To finish with an indication on how to play the above trends, a great example is Rio Tinto (NYSE: RIO). RIO is one of the largest global miners and gets a large part of its revenues from mining iron ore. RIO’s stock price plummeted in 2016 on concerns that iron ore prices would go down to $20 per ton when they were around $40. For such a low price to remain for a longer period of time, the Chinese economy would simply have to stop growing, which is highly unlikely. Therefore, by following longer term trends like the above and comparing them with what is going on in the short term, it’s possible to lower your investing risks and increase your returns.
Figure 7: The market overreacted on temporary low iron ore prices creating amazing investing and trading opportunities. Source: Yahoo Finance.
I have already sold my 2016 RIO position, a bit too early as I bought at $24 and sold at $30. But, if the panic in the iron ore market continues, dragging copper along the way, we could see RIO’s stock below $30 which would make it a great buying opportunity again.
If you want superior long term returns, following macroeconomic trends is essential. I’ve described a few of them in order to show that short term market panics create amazing investing opportunities because long term macro developments and demographic trends are very stable.
The best opportunities at the moment can be found in China. The country has the second best economic growth rate in the world with the second lowest P/E ratio. Such a situation is due to the fact that many got burned on China when the 2015 stock market bubble burst and are wary of investing again in China.
Figure 8: The Chinese stock market was in a bubble in 2015. Source: Yahoo Finance.
Despite the bubble bursting, the economy continues to grow, corporate earnings and dividends also grow, and China is developing extremely fast.
Don’t be concerned by what has happened on financial markets in the past. Be concerned about macroeconomic trends. Many will look back in hindsight and wonder why they were so stupid to pay a P/E ratio of above 26 for the S&P 500 while they could have bought China for a P/E ratio of 7 with economic growth expected to be three times higher than the U.S.