Globalization has been an overarching economic and financial theme for 70 years. But now it’s on hold, maybe even reversing.
“Winter is coming,” warns CI Investments’ global strategist Drummond Brodeur, who believes the world has entered a long-term trend toward protectionism and fencing off of national boundaries.
Since the end of World War II globalization has been on the rise and went into hyperdrive in the 1990s with the creation of the European Union single market and the euro, followed by the entry of China into the World Trade Organization in 2001. Combined with new technologies, globalization opened up significant opportunities, optimized supply chains, and prompted higher corporate profits and margins. “Deglobalization will work in the opposite direction,” warns Brodeur.
The problem is political
Deglobalization has moved to centre stage thanks to a player that remained on the sidelines until now: politics.
“When I started Eurasia Group in 1998,” recalls its founder Ian Bremmer, “the economic impact of political risk was largely contained to emerging markets. In developed economies and in the global economy as a whole, political developments only mattered at the margins. But now that we’re experiencing an unwind of the U.S.-led global order, it’s a different story. Today, geopolitics have become the principal driver of global economic uncertainty.”
The U.S. is the main conductor of protectionism, but certainly not the only one. “There’s rising populism: across EU countries and Brexit in Europe; with America First-led trade battles with just about everyone from Mexico, Canada and Europe to India; with rising tensions between Japan and South Korea,” Brodeur explains.
Not a new phenomenon
Not all observers agree that deglobalization is the new black. David Tulk, portfolio manager on the Global Asset Allocation team at Fidelity Investments, recognizes that there is a move toward protectionism and observes that global trade has not progressed since 2012.
“I don’t know if it really is a change in secular trend or just a cyclical adjustment, he says. I believe a longer trend continues toward globalization, though there can be pauses along the way.”
Long-term trend or short-term hiccup, the present trade situation has introduced a new set of dynamics that investors have to contend with. A first dynamic is interest rates lowering again and reaching the negative return zone in many countries. Fearing the prospect of a global recession, central banks have pressed down once again on rates after trying for a few years to steer them toward higher levels.
The immediate result is a gain for investors already holding bonds. “Since the beginning of this year, total performance of bonds has been very positive in the 6%-7% range,” points out Alex Bellefleur, chief economist and strategist at Mackenzie Investments. However, going forward, the re-leveling of rates at historical lows spells nothing good for investors, believes Brodeur, who now have to deal not only with negative real interest rates, but also with negative nominal rates. “They represent an absolute transfer of wealth from savers to borrowers, he points out. Great for borrowers, very bad for savers.”
Inflation has not yet set in, notes Bellefleur. But that is only a question of time, believes Tulk. “Integration of supply chains helped to lower inflation, he says, but now their decoupling will cause higher costs and higher input prices that will ultimately impact consumer prices.”
R.I.P. modern portfolio theory
Rising inflation and lower interest rates, thinks Brodeur, should prompt investors to rethink a key notion of modern portfolio theory that built portfolios around the two basic asset categories of equities (considered high-risk) and bonds (viewed as low-risk).
That worked great when bonds still delivered 2%-4% real returns. But now they yield a negative rate in the vicinity of -0.5%. Such an investment “is risk-free only in the sense that there is almost no risk of an investor making any money after inflation,” Brodeur jokes.
Tulk agrees. “Inflation is a negative for equities as well as for bonds, he says. Investors are impacted on both sides. They have no place to hide.”
Real assets and diversification are key
Maybe investors can’t hide, but they can take refuge in cash-flow generating assets, advises Brodeur. The classic example is the Italian immigrant who puts his savings in rent producing property. These immigrants “focused on the cash flow of their savings, not on the short-term volatility of the balance sheet,” he points out.
Investors who can’t buy apartment buildings should lower their exposure to government bonds that pay 0-2% and increase it in “real assets” that stand outside the conventional definitions of the two dominant asset classes of bonds and equities: REITs, infrastructure, agriculture, etc.
On the equity side, investors should avoid the reflex of “circling the wagons” and staying home, agree the three commentators we spoke to. Up to the end of 2018, the U.S. carried the day, “but we don’t think they will keep it up, says Bellefleur. One should increase the international share of one’s portfolio.”
David Tulk does not exclude the U.S. as a destination, but only because he favours economies that have a greater capacity for self-sufficiency in a world where trade will become more challenging. That includes the United States, but also China, Brazil and a few other emerging market economies.
Brodeur extends the vista for investors even more. They should be especially attentive to how China will develop its own separate sphere of influence, its own technologies, its own markets across Asia and Africa, independently from the United States.
Major winners will emerge and investors in their stocks will reap the benefits. But that means opening up one’s analysis beyond North America and Europe. “You will need to be more plugged into these geographies and need to identify who can play, who can’t, proposes Brodeur. Things will become more complex.”
