Must-know: Divergence is the new trend in the global economy

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Nov. 20 2020, Updated 11:02 a.m. ET

Economic growth is strengthening in some parts of the world, while it’s slipping in others. In other words, as I mentioned in a post earlier this week, the major trend in the global economy is one of increasing divergence, rather than slower growth, and the uneven nature of the recovery is an important development for investors.

It’s already influencing currency and bond markets. And depending upon the future path of monetary policy in Europe and Japan, it could significantly impact equities as well. Here’s a closer look at the three investing implications of diverging growth.

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Market Realist – The above graph shows the divergence of economic growth in the U.S. (SPY) and the European Union. U.S. markets (IVV) were able to recover after the financial crisis (XLF) of 2008 and the economy has shown signs of stabilizing. On the other hand, Europe plunged into a double-dip recession after the financial crisis of 2008 followed by the European debt crisis, which it has yet to recover from.

Market Realist – The graph above shows the manufacturing indices of various countries like the U.S., Japan, Europe, and emerging nations (EEM) like India (EPI), Brazil (EWZ), and China (FXI). Though the global PMI has risen, the picture isn’t the same everywhere.

The U.S. has shown an increase from 57.1 in July to 59 in August. Europe has seen a significant decline during the period.

Brazil (EWZ) and Japan (EWJ) have both seen an increase from July levels. China (FXI) and India (EPI) seem to have declined a little but are in a better position than they were in the first quarter of the year.

Market Realist – The above graph shows the balance sheet size of the Federal Reserve, the European Central Bank, the Bank of England, and the Bank of Japan. You can attribute the uptick in the Fed’s assets to the quantitative easing program, which involves purchasing ten-year U.S. Treasuries (IEF). The program is set to conclude in October this year and the Fed’s balance sheet size will likely decrease thereafter.

Europe is reeling under the recession, which has completely stalled growth in the economy. The European Central Bank or ECB has announced buybacks of asset-backed securities akin to the quantitative easing program of the U.S. So the ECB’s balance sheet size, which has been declining so far, is likely to increase.

As the U.S. economy is recovering, the Fed is contemplating a less accommodative monetary policy involving a hike in interest rates. The European Central Bank and the Bank of Japan are likely to follow an easy monetary policy instead. This divergence could affect the markets in the coming months.

Read on to the next part of this series to learn the implications for investors.

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