Most Brits remember the tale of King Canute, England's revered 11th-century king. Legend says his adoring subjects declared he was so powerful, he could command the tides of the sea to retreat. Despite the admiration, Canute knew his limitations and in a quest to prove he was not almighty, he sat on his throne on the seashore for hours as the waves defied his commands to retreat. His intention was to prove that while the might of influential entities may appear great, it's nothing in the face of a stronger power.
Like King Canute and with global investors as witnesses, the American economy will prove it is neither almighty nor does it have the ability to single-handedly stem the tide of global economic expansion.
For the sixth straight year, non-US equities outpaced American counterparts in 2007. In fact, of the 23 developed markets in the MSCI World Index, only five performed worse than the US. With increasing frequency, many pundits attribute non-US stock leadership to a reduced reliance on the US economy. The idea is global economies had built an immunity to the effects of allegedly flagging US consumer demand and a much-feared (but as of yet, not arrived) US recession by creating stronger consumer bases abroad, making non-US stocks more attractive. The term "decoupling" emerged to describe the supposed independence and remained en vogue, particularly in Europe, until two weeks ago.
In the wake of weak US economic news, decoupling proponents expected other countries to fare better than America. But with the opposite happening during the current market correction, decouplers have sheepishly withdrawn support for the theory. Broader and more diverse consumer bases is a favorable development, but whether or not decoupling is an achievable or advantageous development is largely irrelevant—and based on faulty historical perspectives.
Decoupling is rooted in the belief that when America sneezes, the world catches a cold. Perhaps haunting memories of the US-led tech boom-bust and ensuing bear market continue impeding investors' vision. Fortunately, there's hope for those suffering from this condition.
Recall, Europeans weren't clamoring to segregate themselves from the US economy in the late 1990s. Nor was there a movement then for the US to separate from floundering emerging market economies or the lagging economies of Europe and Japan. The US, which represented about 30% of the globe's economy at the time, helped buoy the rest of the world, just as the rest of the world will do for the US now.
In 1999, leading into the last bear market, America accounted for about a quarter of the world's economic expansion, so when the US began sputtering, it created a significant drag on global growth. Based on International Monetary Fund (IMF) projections and weights, we calculate the US could account for less than 8% of global growth in 2008.* Yet, the IMF predicts 4.1% global growth this year, which, incidentally, is more than the global economic growth of any single year during the latter half of the last decade.
Furthermore, the US now accounts for only about a quarter of the world's economy. Emerging markets now generate about the same amount of global economic activity as the US and Europe respectively. Although the IMF projects moderate to slow growth for the US and developed European economies, developing economies are expected to expand by 6.9% in 2008. Chinese growth, in particular, is projected to remain strong at about 10%.
What's more impressive is a non-US-led economic expansion could be even more robust than the late '90s. The US was among a very small subset of strong economies in that timeframe. IMF growth rate projections suggest the global economy could grow by $2.5 trillion in 2008 in real terms (2007 dollars). That is roughly twice the value of global GDP growth in 1999, even after removing the impact of inflation over the interim.*
A slowdown in America does not portend economic disaster for the world. Rather, it reinforces the importance of global investing and reminds us that as influential as the US economy is, it alone is not mighty enough to turn back the overwhelming tide of global economic expansion.
* Sources: "International Money Fund, World Economic Outlook Database, October 2007" and Fisher Investments