Eurozone Recession, Global Growth

With aggregate eurozone GDP contracting in Q4 2011 and the European Commission forecasting a Continental recession in 2012, investors may wonder what a eurozone recession means for the global economy and equity markets. In our view, 2012 is likely to feature strong bull market equity returns, and the world, on balance, can continue growing just fine while one region—even one as big as the eurozone—contracts.

In fact, there are two fairly recent examples when a significant region contracted, but the world overall grew and stock returns were strongly positive. Consider 1998 and the so-called Asian Contagion. That year, Asia experienced a severe financial crisis, causing the region's GDP to contract by more than 1%. At that time, Asia accounted for about 25% of global GDP (nearly identical to Europe ex-UK today), and many feared the world economy would catch the "Asian flu." US stocks corrected nearly 20% mid-summer as fears spread and a large US hedge fund, Long-Term Capital Management, collapsed. Yet, as shown in Exhibit 1, the world economy was largely unaffected—global GDP rose 2.4% in 1998 and even faster in 1999. US GDP growth was even stronger at 4.5% in 1998 and 4.9% in 1999. World stocks were just as resilient, with the MSCI World Index rising 24.3% in 1998.[i]

Exhibit 1: Aggregate Asia/Pacific Region and Global GDP Growth, 1992 – 2000

Source: World Bank.

The second example is perhaps even more compelling. In 1992 and 1993, as the rest of the world continued growing following the 1990-1991 global recession, GDP fell across continental Europe—a true regional "double dip" as shown in Exhibit 2.

Exhibit 2: Aggregate European and Global GDP Growth, 1992 – 1995

Source: Thomson Reuters.

Europe's weakness then was tied to Continental monetary disarray—not unlike today's fear of a messy and sudden dissolution of the monetary union. In 1979, European countries harmonized exchange rates in an effort to slowly converge national currencies in preparation for euro adoption. The goal was to limit economic adjustments when the common currency finally took over, but as often happens, unintended consequences ensued. After the global recession, most core European nations would likely have benefited from accommodative monetary policy, but the fixed exchange rates prevented this. During and after the 1990-1991 recession, post-unification Germany actually grew briskly, and Bundesbank officials were more concerned about inflation in former West Germany—hence, they were tightening. Because other nations were allowed only minimal room to deviate, they had to follow Germany's hawkish lead, choking their nascent recovery.

This crisis escalated throughout 1992 until reaching the breaking point in September, when the UK exited the exchange system after currency speculators "broke" the Bank of England. The economic fallout from the system's unraveling continued into 1993, but it was very much localized to Europe—much like today's eurozone troubles seem to be. And, importantly for investors, global stocks defied Europe's woes. After a small drop in 1992—similar to 2011's flattish returns—the MSCI World Index rose a healthy 22.5% in 1993.[ii] Partly because the broader global economy was still growing, but likely also because stocks had already discounted Europe's weakness in 1992 (much as they grappled with PIIGS consternation in 2011). Stocks move on future expectations, and by 1993, they were likely already looking toward the coming global economic boom. 

Outside of the eurozone, the global economy seems healthy and even accelerating in spots. And though it is likely—and markets seem to fully expect—the eurozone in aggregate contracts, recall the region isn't uniformly weak. Pockets of strength like France and Germany may serve as a counterbalance to the weaker periphery. Still, history is clear regional weakness needn't drag on global stocks.

-=\(This article constitutes the views, opinions, analyses and commentary of Fisher Investments as of March 2012 and should not be regarded as personal investment advice. No assurances are made Fisher Investments will continue to hold these views, which may change at any time without notice. In addition, no assurances are made regarding the accuracy of any forecast made herein. Past performance is no guarantee of future results. A risk of loss is involved with investments in stock markets.) 

[i] Source: Thomson Reuters, as of 12/31/2011.

[ii] Source: Thomson Reuters, as of 12/31/2011.