End of the line?
MIKE REYNAL 12-Aug-2019
Earlier this summer, Chinese President Xi Jinping and United States President Donald Trump traveled to Osaka, Japan, for the G20 summit. The meeting held out hope that the leaders of the two largest economies in the world—and the two principal combatants in this new era of trade turmoil—would produce a comprehensive trade deal. So much for that.
We now seem to be entering a new phase of escalating tensions. In early August, based on the “lack of progress” on trade talks, President Trump surprised markets and announced plans to increase tariffs on $300 billion worth of Chinese goods that had been exempt. China followed by allowing its currency to drop sharply, and then the U.S. labeled China a currency manipulator. And on it goes.
There’s no denying that globalization has been losing steam. If protectionism grabs hold and tariffs are implemented for a protracted period, economic growth will falter. Although nobody knows how the current nationalism trends will manifest in future trade policies, there is still a feeling that more sensible minds will prevail and that globalization, ultimately, is unyielding. Moreover, any setbacks and subsequent market volatility might provide opportunities for active managers, particularly emerging markets investors who may be able to capitalize when stock prices disconnect from fundamentals. But buckle up, because it’s bound to be a bumpy ride in the near term.
History as our guide
I fully acknowledge that there are tangible risks to globalization today. But as an equity manager with a global perspective, I still believe in trade liberalization and its ability to lift both developing and developed countries. There may be setbacks along the way, and cross-border capital flows may still be below peak levels from a decade ago, but rising protectionism actions and rhetoric are unlikely to completely reverse globalization.
Globalization is driven by four key factors: cross-border capital flows, trade, migration, and the free-flow of ideas and communication. Capital flows, trade and to some extent migration may have hit a speed bump, but the overall exchange of ideas and knowledge continues unabated. This era of digital globalization and knowledge-sharing is still in its infancy, and the amalgamation of cross-border ideas still looks like an unassailable historical force to me. A recent IMF publication summarized it well, explaining that we may be in a new era of heightened political resistance, but that any “drag from politics seems weaker than the thrust from technology. Absent some truly cataclysmic shock—something akin to a world war or a depression—the best bet is that globalization will march on.”¹
When the headlines appear dire, I harken back to 19th century economist David Ricardo, an unabashed proponent of free trade and developer of the theory of comparative advantage, which suggests that individuals or nations are better off when they trade for products or services that can be created more cost-effectively elsewhere than at home. This free flow of goods and services has been the avenue to rising standards of living globally, and it has provided access to a wider array of goods and services available at a lower price for all participants, especially those in developing markets.
Yet, we must also acknowledge that globalization has resulted in uneven economic growth among nations, as well as disruptions across various sectors of the economy. This has manifested itself in varying degrees of resentment, nationalism, and more recently, protectionism. Already the U.S. has applied tariffs to approximately $250 billion worth of Chinese goods, and the Chinese have responded in kind with an estimated $110 billion of U.S. products. No doubt about it, these types of protectionist measures could create near-term pain for global investors. The Organization for Economic Co-operation and Development (OECD) has estimated that a 10% increase in trade costs could lower Global GDP by 1% in the medium-term.² That’s not insignificant.
Once protectionism grabs hold, it runs the risk of spawning a vicious cycle of tariffs, undermining consumer confidence, and elevating geopolitical tensions. In such a scenario, consumer costs would likely rise. Supply chains could be disrupted, potentially leading to job losses. And the stock market, a proven discounting mechanism, would certainly presume lower earnings.
That’s just one possible dystopian economic future, but the likelihood of such a bleak scenario where economic liberalism is completely derailed is a long-shot, in my opinion. There’s simply too much to be lost on all fronts. In China, for example, the Central Authority must hold up its half of the tacit agreement whereby Beijing continues on a path to economic liberalization (albeit not always as quickly as hoped) in return for stability, peace and control.
In times like these, it’s incumbent upon investors to retain their longer-term focus and commitment as to why they are allocating to emerging markets. That might be to capture potential higher rates of growth, to diversify return streams, or even to diminish their inherent home-country bias. Moreover, emerging markets often tend to over-react to macroeconomic developments in the short term, and this can provide opportunities for active managers.
It’s also important to remember that protectionism is not exactly new, and it’s not only about headline tariffs. Protectionism is also about “local content” rules, licensing, rules of origin, labor and immigration, environmental rules, domestic sourcing requirements, and myriad other issues. As emerging markets investors, we’ve been dealing with these challenges for many years, so we take the latest actions and rhetoric in stride and are confident that we will continue to find ways to uncover opportunities in fast-growing and exciting developing markets.