Who Gets Sick When the U.S. Sneezes?

Written by: John Manley

With the U.S. economy decidedly late cycle and the bull market looking to some, at least, a bit long in the tooth, international investment opportunities seem increasingly attractive. Valuations, on a relative basis, are closer to “fair” (average) than in the U.S., and earnings expectations are both looking up and not yet near prior peaks. Furthermore, a falling dollar should amplify international returns for USD-denominated portfolios.

That said, some investors remain hesitant to embrace overseas equities, with some citing concerns that an end to the U.S. cycle could spell an end to cycles elsewhere, too. But is this a valid concern? Or, to borrow an old expression: when the U.S. sneezes, does the rest of the world catch a cold?

As the world’s largest economy by a factor of nearly two, it would seem at first blush that trouble in the U.S. spells trouble for everyone. But perhaps surprisingly, history tells us a slightly different story. Looking at the OECD’s leading indicators survey, it appears that when the U.S. economy reaches a turning point – that is, a peak in economic growth with a subsequent slowdown – the rest of the world only meaningfully decelerates if the deceleration is extremely severe. During the global financial crisis, for example, 82% of tracked non-U.S. countries (OECD members plus six large non-member economies) similarly peaked within 12 months of the U.S. But on average, this number is under 40% for the 11 U.S. turning points over the last 50 years, and whether or not the downturn leads to recession doesn’t have a material impact on contagion: of the six recessions analyzed, only half resulted in more than 50% of tracked countries peaking.

Related: Do Valuations Matter?

Most U.S. economic downturns are minimally contagious

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OECD Composite Leading Indicators system identifies business cycles and turning points using deviation-from-trend analysis. GDP is used as the reference for identification for all countries except China, which uses value added of industry at 1995 prices. Countries analyzed include 33 OECD member countries and six non-member economies: Brazil, China, India, Indonesia, Russia and South Africa. Blue bars denote business cycle peaks that ended in a recession. Two recessions followed the 1978 downturn: one from January 1980 to July 1980, and one from July 1981 and November 1982.
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