As headlines of sovereign debt woes, liquidity worries, rising risks and stumbling Chinese economic indicators mount, one conclusion is hard to escape: The global economy is headed for a rough patch. The recently accelerating recovery is about to feel some heavy feet pressing on the brakes - from European ripple effects, from Chinese constraints, from belt-tightening governments everywhere - and that's rarely a happy event for investors.
CIBC World Markets economists Benjamin Tal and Meny Grauman said in a report this week that while global gross domestic product growth should be an above-average 4 per cent for the year as a whole, that growth is weighted toward the first half of the year, with a slower pace likely in the second half of the year. Should the pace slip below its long-term historical average (which is roughly 3 per cent over the past 30 years), that would represent a danger zone for the world's stock markets.
Below-Norm GDP Awakens Bears
Historically, the MSCI world equity index generates annual returns of better than 15 per cent when global GDP growth exceeds its historical average, but when the world economy slows below those long-term norms, the MSCI averages a 5-per-cent annualized decline.
Canada is far from immune to this global trend. In fact, the Canadian equity market has become highly correlated to non-U.S. global stock markets over the past decade - and, the CIBC economists' research shows, the correlation is even higher in weak times for global stocks than in strong ones. If global stock markets are going to go down, Canada is all but certain to go down with them.
Yet despite this bleak prospect outlined by Mr. Tal and Mr. Grauman, they do say that there are investments in Canada that are more sheltered from global storm clouds than others.
"The good news is, there are some options," they wrote.
They noted that traditionally defensive sectors of the Canadian equity market - telecoms, health care, consumer staples - have low correlations to overall world equities in times of weak global stock performance. (By contrast, financials and the major cyclical sectors are most closely tied to weakness in worldwide equities.)
They added that if investors look beyond equities, "we find a number of additional pockets of protection that tend to provide some shelter to investors during periods when global stocks are under pressure." In particular, they noted, a basket of major global currencies typically rally impressively when global equities slump.
Canadian bonds have also historically shown modest upside in times of global equity weakness. However, they cautioned investors away from this particular play this time around, citing the fact that the Bank of Canada has started a rate-tightening cycle - typically a negative for bond prices.