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De-globalisation: The long goodbye

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6 Jun 2022

The world could be entering a new era, one of de-globalisation. Andrew Holt looks at whether this is truly a new epoch and what it means for investors.

deglobalisation

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The world could be entering a new era, one of de-globalisation. Andrew Holt looks at whether this is truly a new epoch and what it means for investors.

deglobalisation

New thinking has started to pervade investor circles. A belief that we are entering a new epoch, an era that will see a reversal of the many facets of globalisation.

A big authority on this is none other than Larry Fink, chief executive of asset management behemoth BlackRock. Fink has said the Ukraine conflict has “put an end to the globalisation we have experienced over the last three decades”.

Has Fink called it right? Is de-globalisation where we are? “He’s absolutely spot on,” says Stuart Trow, former credit strategist at the European Bank for Reconstruction and Development. “What is confusing the issue is all the noise – the war and the pandemic. Global trade has been falling as a proportion of global GDP since the financial crisis, unwinding the downward pressure that globalisation had been exerting on inflation.”

Neil Mason, assistant director, LGPS senior officer, at the Surrey Pension Fund, agrees, citing trends dating back over a decade. “There has arguably been evidence of a drift towards more autarkic economic conditions since the financial crisis,” he says. “Government intervention in 2008 and then during the Covid crisis has been localised and contradicted globally connected economic systems.”

Strong narrative

These views are supported by analysis undertaken by economic forecaster, Oxford Economics. “Financial de-globalisation started in the global financial crisis and accelerated in the pandemic,” says Charles Burton, a director at Oxford Economics. “While global cross-border claims have grown, the pace over the past decade-and-a-half has slowed. And when considered against the backdrop of the vast global monetary expansion, it’s clear that the global financial system has become more insular.”

John Roe, head of multi-asset funds at Legal & General Investment Management (LGIM), appreciates the de-globalisation idea, but says the evidence, at least so far, does not back up the grand narrative shift. “It’s a credible and strong narrative, but not yet backed up by data. Believable narratives can come true, but they can also be dangerous, as they can tap into natural biases and lead people to place too high a likelihood on one risk really occurring,” he says.

“The lack of evidence could just reflect the lag before activity shows up in the data,” he adds. “But global trade volumes continue to rise and for the last decade or so have been a largely constant share of industrial production.”

Nowhere to hide

If we take what is happening as a big shift, it means investors have much to ponder. For one, the macro-economic picture will change, Trow says. “The background level of inflation will be higher than we have been accustomed to, even if inflation moderates from here. This is already altering central bank behaviour. Policy is being tightened even as the growth outlook stalls,” he says.

“This has started the process of normalising bond yields. So, there is literally nowhere to hide, as risk and risk-free assets sell off in unison.” This is already evident in the challenge it poses to investors wanting to achieve the correct balance in their portfolios.

Roe also warns of the inflationary picture and the related investment impact. “If de-globalisation were to occur, it would be unambiguously inflationary and likely lead to falls in real incomes, lower average living standards and require much more hawkish central banks. That would cut growth, equity returns, bond returns and potentially lead to a prolonged period of recurring stagflationary and recessionary risks.”

Setting out his pension fund’s position, Mason says: “We will still look for quality and value across intercontinental regions. “But, arguably, the risk premium has increased. Whether this is through accounting for more overtly protectionist economic circumstances or reflecting local strategies, including aspects like ESG,” he adds.

Roe says the biggest implication for portfolio construction is likely a reduction in confidence that government bonds provide protection in a range of downside scenarios. “To some extent this would be an extension of the current dynamics, but with a much more structural element,” he says. “We already consider the changing behaviour of bonds within our asset allocation process and we would aim to capture evolving issues like de-globalisation within that framework.”

Lock in gains

So, could it mean a huge re-think of asset allocation strategies, given the international nature of many institutional investor portfolios? “Not fundamentally,” says Mason, adding: “We are re-assessing the emerging market growth story in light of geopolitical realities.”

But Trow believes this could potentially happen. “When bond yields were being depressed by quantitative easing, it left many funds with little alternative but to channel discretionary flows into equities,” he says. “I know of several pension funds that have seriously examined de-risking in recent years, seeking to lock in gains. Invariably though they concluded that bonds were an even bigger bubble than equities and that there was little choice but to remain overweighted stock.”

The deflationary impact of globalisation has been a key feature of the last few decades. “A full blown reversal would have large implications for investors’ future returns and how asset allocators try to construct portfolios,” Roe says.

This presents many challenges for investors. “Paradigm shifts can be particularly painful in asset allocation, with previously successful approaches deeply ingrained in many thought processes,” Roe adds. “That said, for now there are many obstacles to it occurring. Also, the speed over which it occurs would be an important factor, with quicker, more disorderly change leading to greater risk for asset markets.”

One thing investors do have is time. Oxford Economics’ Burton says that when it comes to the speed of de-globalisation, the process will be a steady affair. “De-globalisation is unlikely to be a ‘big bang’ but more a creeping tide of targeted measures by individual countries,” he says.

Winners & losers

The situation throws up an interesting position for bonds, says Trow. “With government bond yields now rising, the point will come when investors once again start to see them as a viable means of reducing risk. This will keep a cap on equity rebound potential,” he says. “A rather surprising loser in the current crisis has been index linked gilts,” he adds.

“Which raises issues about the market’s effectiveness as either an inflation or rate hedge.” Where will the investment winners be in this new world? “It’s not really a ‘winners’ kind of environment, with global growth likely to also be slow,” Trow says.

“Relatively speaking though, those countries and sectors least dependent on trade. Remember Germany was within a whisker of recession even before the pandemic because Europe was the biggest loser of the US-China trade war,” he adds.

Roe says de-globalisation could lead to a lot more losers than winners. “Globalisation enabled specialisation and reduced the cost of many goods in real terms, allowing developed markets to run high levels of consumption through consistent net imports from producers abroad.” For investment winners, a lot depends on the mixture of policies used, says Roe.

“There are, for example, circumstances where technology firms could benefit, with their intellectual property and products still more easily able to cross barriers, but tech revenue taxes, for example, would potentially negate that.” The most probable route for de-globalisation would be one where there is less trade between developed and emerging markets, particularly in goods, says Roe.

“This would put great pressure on labour availability and costs in developed countries, leading to relative winners in areas that support capital spending aimed at increasing worker efficiency.” Areas like robotics, automation and materials providers would seem well placed on a relative basis, Roe says.

“Other winners would potentially be those emerging markets that still remain integrated with nearby, more developed neighbours: for example, eastern Europe and Mexico, which could see extremely supportive dynamics.”

Mason, though, is unmoved. “Short term there has been a traditional rush to defensive sectors – commodities, etc – but these sectors are not sustainable long term in their current form. And we are in it for the long term.”

From a macro-economic perspective, Richard Bullock, Newton Investment Management’s geopolitical research analyst, says everyone is a loser under de-globalisation. “One of the major implications of a de-globalised world in which fewer goods, capital and ideas traverse borders as a portion of GDP is a level of overall lower productivity growth and higher inflation,” he says.

Although, for Burton, not all macro-economic scenarios connected to de-globalisation hang together. “Suggestions of the dollar losing its reserve currency status or a large ‘Eurasian’ world trade axis arising, look to be exaggerated,” he says.

Domestic investment

De-globalisation could well lead to a retreat from global investments to ones closer to home, like infrastructure, which to the home country involved can only be a good thing.

“It certainly should do,” Trow says. “The most economically sustainable stimulus is to invest in things that increase domestic productivity. That’s far less likely to stoke inflation than something that merely temporarily lifts demand.”

Mason says this will be determined by the extent of government intervention. “If the government either makes local investments relatively more attractive or, in the case of the LGPS, there is more of a move to ‘command and control’ then nationalistic investing will become ‘a thing’.”

Otherwise, Mason says, investment fundamentals are unchanged. “That is, looking for quality assets with long-term risk-adjusted return characteristics. As mentioned earlier it is likely that the focus will be on the risk premium attached to these assets.”

Roe highlights other challenges. “It would lead to the need for a lot of capital spending domestically in a lot of countries,” he says. “It’s less clear if it would lead to a lot more infrastructure spending though. Real incomes would grow more slowly than otherwise, putting pressure on fiscal positions, for example. “To the degree that certain forms of infrastructure directly improve worker productivity,” Roe says.

“Then those areas would likely get increased support. Unless there are explicit government-led restrictions, it’s not obvious to me that it would increase local investment – with such high uncertainty over outcomes, the importance of diversification would appear as high as ever.”

Could this in turn lead to a more ‘nationalistic’ form of investment, as when globalisation reverses, nations and investors become more inward looking?

“In a de-globalisation scenario supply-chain issues are largely going to be remedied by swallowing the cost of at least some on-shoring,” Trow says.

“Maybe marginally,” Roe says of a nationalistic investment surge. “There’s definitely some evidence that certain types of investor already prefer domestic investments for reasons like the indirect effect it has on the domestic economy. But the big dial mover would be central regulation that made overseas investment unattractive or restricted it.”

Trow adds a national-focused approach has implications on a climate-change level. “Hit by a sudden growth deceleration, India and others have increased coal investment as an import substitution strategy and as a means of securing jobs, even though solar is far cheaper for the economy as a whole.”

Faraway markets

David Krivanek, programme manager for international development at the Impact Investing Institute, makes the point that whether investments are made in faraway markets or closer to home, what matters is they are grounded in need, and focused on solutions at national, regional and local level. “The adoption of a localised approach provides an alternative to de-globalisation,” he says.

So, a national and local investment approach here is antithetical to de-globalisation, not an extension of it. Some investors are already leading the way. “Pioneer institutional investors are showing the way in allocating their assets in a way that is consistent with the needs and incorporates the voices, of the local communities in which it is invested,” Krivanek says.

“This may include place-based impact investments supporting local regeneration or affordable housing, or infrastructure investments that help communities move to sustainable sources of energy in a socially inclusive manner.”

There could be a scenario where a more nationalistic-focused perspective faces-off with the challenges presented by ESG. “The question of ESG and engagement is an interesting one, and it is important that investors’ view this from a non-Western centric neutrality,” Mason says.

“For example, there is some emerging evidence that shareholder power in the US may be polarising consistent with the general political landscape.” This could see cases such as anti-decarbonisation shareholder resolutions, Mason says. “Developments such as this would put the E in responsible capitalism in potential conflict with the US compared to the big emerging market players like China, where the ‘S’ and ‘G’ have been more problematic,” he says.

Global and local

It could, therefore, be within the ESG arena that de-globalisation has its greatest impact. Krivanek makes the investor connection between de-globalisation, ESG and a world that will still remain globalised in many respects.

“While there may be a push towards de-globalisation in some parts of the market, responsible investors cannot ignore that environmental and social challenges are global as well as local,” he says. “Meeting the Paris Goals – which a growing number of institutional investors have now committed to – requires investment at scale for a fair and inclusive transition to net zero in developed and emerging markets,” Krivanek adds.

Roe also sees the shifting de-globalisation impact on ESG. “In many ways, the most likely cause for de-globalisation might actually be the need to tackle climate change. Reducing the use of transportation can play an important role here and if there’s sufficient pressure from investors and regulators, that could lead to more onshoring and less commitment to truly global supply lines.”

For Trow, a key issue is the outlook for inflation. “It was globalisation that was largely responsible for moderating inflation, not monetary policy. Globalisation suppressed inflation by increasing the supply of cheap goods and depressing wage growth in more developed countries,” he says. “Reversing the process means less downward pressure on prices and somewhat increased labour pricing power. Sanctions, tariffs and the growing need to add resilience to supply chains all imply additional cost, boosting background inflation.”

So, for all the assertions of a grand narrative shift, a de-globalised world could well prove similar to the globalised version.

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