The headwinds to globalisation are more structural than cyclical, which means those in favour of open markets have a serious challenge to overcome.
There’s a lot of talk these days about Donald Trump’s pro-growth agenda, which most likely consists of stimulating domestic growth at the expense of overseas growth (benefitting small cap equities more than large caps because of their higher domestic exposure). This is protectionism as we know it. But is “America First” a unique story? Far from it, protectionist measures have been on the rise for some years globally even as global trade has cooled.
One of the primary reasons for the backlash against globalisation is globalisation itself. Recent decades have brought down many barriers and borders, which has created a lot of winners in terms of trade and finance. But the shift has also left large parts of the western middle class behind. Cheap jobs in emerging markets have crowded out more expensive jobs in the developed world. The resulting public anger has paved the way for populism, resulting in a global wave of protectionism.
As a consequence, the world is currently witnessing the revival of more controlled capitalism. Democracy, national sovereignty and global economic integration have proven to be an impossible trinity in several key countries and politicians seem willing to sacrifice the latter. This is not simply a case of establishing protectionist measures—it is becoming immanently clear just how difficult it is for policy makers to agree on large-scale trade agreements nowadays. The US pulling out of TPP is a case in point. Brexit is another example of more inward-looking politics.
Amid all of these changes, it’s important to understand that the underlying reasons are structural. And as neither the low growth environment nor current political trends are set to change on a global level, de-globalisation is a trend, not an intermezzo and is clearly leaving its footprint on global trade. A closer look reveals that stagnating trade cannot simply be explained by lower overall growth. The trade intensity, i.e. the amount of trade created by one unit of growth, has fallen significantly. This is important, as it shows that even higher growth does not offer a solution in itself. The headwinds to globalisation are more structural than cyclical, which means those in favour of open markets have a serious challenge to overcome.
So, what’s the way forward?
As protectionism turns the tide against globalisation, it also favours domestic sales over foreign sales. Domestic exposure therefore should have higher relative weight in equity portfolios than it used to have. In fact, America’s new pro-growth agenda has thus far been well received by equity markets. As such, the small cap segment appears an attractive choice, having a much greater concentration of domestic sales than its large cap equivalent. De-globalisation is expected to continue to benefit small cap equities relative to large cap companies. In addition, smaller companies offer an attractive liquidity premium which can be harvested by investors willing to tolerate higher volatility than in the large cap segment in general. That said, a protectionist trend – if extrapolated - is a risky path to follow over the very longer term. Being a “negative sum game” in terms of global growth, protectionism also poses risks for risk assets further down the road.
Witold Bahrke , February 6
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