The world economy appears to be taking a different shape this year with a stronger U.S., while most major countries throughout the world are starting to stagnate. On the surface that might imply a greater emphasis on domestic investments, and a reduction in foreign holdings, however this will likely not be the start of a long-term trend, but something more unique to 2012.
Until the past 10 years, the U.S. had been the major engine of growth throughout the world. The past decade China, India, and Brazil were the large countries with the most impressive growth rates. This year all three countries are seeing growth slow, as they try to combat inflation. Because these countries have relatively high interest rates, they have the ability to lower rates when inflation eventually subsides. Also the 8 to 10 percent annual growth rates China enjoyed over the past decade are not sustainable, though I believe China and India should still see annual growth over 5 percent for the next decade with Brazil slightly lower.
Switching the focus to Europe, the problems they are experiencing this year are not a major surprise. If anything the situation in Europe is not as dire, as the financial markets were indicating last year. It appears that Europe will avoid a major financial meltdown that would impact the world economy, though a number of countries will experience recessionary conditions this year. Eventually growth will return to Europe, but will not be anything close to what the rest of the world will experience.
The U.S. is seeing stronger growth this year in part because we are one of the few countries that are still engaging in significant monetary and fiscal stimulus. Our tax rates are being kept artificially lower in part due to the social security tax cut, and the Federal Reserve is still keeping interest rates at essentially zero. Countries in Europe are engaging in fiscal austerity, while emerging market countries have relatively high interest rates. Once we get past the election some of this stimulus will likely come to an end, though a stronger employment and housing market may cushion things to some extent.
Because I see the relative out performance of the U.S. economy as being temporary I would not advocate selling international investments to purchase U.S. stocks. Also while the American stock market is reasonably valued based on expected earnings this year, markets in the rest of the world are more favorably valued. In addition a substantial portion of U.S., company earnings are dependent upon foreign markets. Many large European and American companies essentially compete in the same global markets, though some of the European companies may be more attractively priced.
A slower world economy this year may also help to keep a lid on oil prices, as global energy demand should not increase that much. Assuming the situation in Iran doesn’t worsen significantly then we have most likely seen the bulk of the gasoline price increase for the year. If energy prices do not rise much from here, then keeping normal positions in stocks is still appropriate.