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Deglobalisation – The Impact For Stock Markets

People invest in stock markets because they have historically gone up. The long-term return from the stock market is a little over 5%, higher than that of bonds or cash. To what extent has globalisation played a role in this? And therefore, does its reversal suggest tougher times ahead for investors?

The KOF Globalisation Index shows globalisation gradually gathering pace through the 1970s and 1980s, only to see huge gains in the 1990s and through the early part of the 21st century.

The 1990s were certainly a buoyant time for stock markets and economies in general, which might suggest globalisation played a role. It would make intuitive sense. As barriers between countries come down, companies have access to new markets, they can make cross-border deals more readily. They can outsource manufacturing to cheaper countries and harness global expertise to build products. It helps revenues and margins.

As such, the rapid reversal of globalisation would be a cause for concern. This hasn’t just happened since the accession of Donald Trump. The globalisation index went into reverse as early as 2015 and it continues to decline. It is clear that the beneficiaries of globalisation have largely been emerging markets, and many developed markets have grown increasingly reluctant to share their wealth.

As a general trend, companies could see the opposite effect to that brought about by globalisation: their range of potential markets will narrow, cross-border deals will fall away and companies will find it more difficult to hire global expertise. The machinations of politicians are likely to be a headwind to corporate growth where once they underpinned it.

A recent JPMorgan report on deglobalisation shows that there has been a very tight correlation between “cross-border trade intensity” and US corporate profit margins over the past 20 years. Large-cap companies in particular “have greatly benefited from locating labour, factories and resources in countries with the most beneficial wage costs, taxation, regulations and infrastructure”.

However, it’s not that straightforward. Looking at stock market returns, there is little correlation between the era of rapid globalisation and stock market returns. The stock market rose at roughly the same pace during a period of far slower globalisation – the 1970s and 1980s. While there are clearly other factors at work, it does suggest the relationship isn’t linear.

David Jane, a multi-asset fund manager at Premier Miton Investors, points out that there are plenty of industries that will benefit from globalisation – renewable energy, for example: “Globalisation was, to a large degree driven by cheap fossil fuels. Fossil fuels are the key to long distance transportation and therefore offshoring replaces developed market labour with cheaper emerging market labour and transport costs. Renewables generally produce electricity, which is a poor transport fuel as batteries are heavy compared to fossil fuel.

“However, renewable energy is now cheaper than fossil fuels for most purposes. If transportation is becoming relatively more expensive and inefficient then the attraction of local production close to the end market becomes much greater.”

The trend to ‘reshore’ production is perhaps not as established as Donald Trump would like but appears to be happening at the margins. Apple, for example, recently took the decision to manufactures its Mac Pro in Texas, abandoning its original plans to move production to China. This is typical – the Mac Pro is the most powerful in the group’s range and requires greater technical skill.

“Greater domestic production will require a higher level of automation as cheap emerging market labour is replaced by a more expensive and skilled developed market labour, supported by robots and other new technologies. In the long term we expect manufacturing to become cleaner, highly automated, highly customisable and close to its customer,” says Jane.

He believes the big loser from deglobalisation is Europe. Exports from Germany have been an important driver for the European economy for many years. These have been directed towards China and recent weakness has been a major cause of the current slowdown in Europe. Europe has relatively weak domestic consumption so has relied on outsiders to buy its goods. This will be more difficult in an era of deglobalisation.

Mckinsey’s Anu Madgavkar, points out that not all forms of trade are declining or flattening in a deglobalizing world: “Trade in services is rising. All sorts of data flows and information flows, which indirectly enable trade in services, are skyrocketing. If you strip away the pure commodity piece of goods trade, the rest is demonstrating healthy growth as well.”

She says that there is also a tendency to think only of trade flows to and from developed markets. She points out that intra-regional trade in emerging markets is blooming: “There are these big economies like China, which have created value chains and are sourcing more from the rest of the emerging economies and potentially importing for domestic consumption as well. We’ve seen labour-intensive exports from countries like Bangladesh, Cambodia, Vietnam, Uzbekistan, rising at the rate of 20 to 30%, directed toward China… there is the opportunity for China to become a new engine of consumption.”

The globalisation experiment may be starting to reverse. On the face of it, this looks like bad news for markets, but just as globalisation has not necessarily acted as a boost to stock markets, deglobalisation is not necessarily leading to a reversal in trade flows. The real picture is more complicated.
Source: Forbes

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