Nationalism is taking over from globalism, but not even these seismic changes can damage US equities, writes Annamaria Koerling
I found myself in Hong Kong, Australia and Japan at various points during this summer of unrest. Whether it was experiencing the protests first-hand in Hong Kong or witnessing the consequences of a very strict immigration policy on the demographics of Japan, I was struck powerfully by the sense that we may be experiencing an end to globalisation and found myself wondering what the consequences are likely to be and how investors should respond.
The undertone to the trade tensions is one of nationalism. The simple logic seems to be that by prioritising national interests, more of the wealth created is likely to be retained, more of the taxes are paid domestically, and there is greater fairness and stability. This seems to be President Trump’s argument, and Brexit is not unrelated to this. Brexit seems to have become a touchstone for a range of issues including immigration, stagnating wage growth, lack of security resulting from flexible working, and affordability of housing. For others the argument is more about sustainability than fairness: if goods and people travel less, this is a more ‘responsible’ and sustainable way to live, even if we have to set our personal sights lower.
The counter argument is that global value chains are being reshaped by technology, with many goods and services inhabiting a virtual rather than physical world. Many companies can choose where to locate themselves and where to pay their taxes. By closing borders and minds to the new global dynamics, you limit not just the threats but also the opportunities. Some argue that Japan is paying this price.
Is it possible to have your cake and eat it? Can you profit from global opportunities, attract global service companies, while sheltering your citizens and protecting the environment? Australia is trying to achieve this and certainly seems to be thriving, aided in this goal no doubt by geography. Immigration policy is strict (just look up Christmas Island), but you cannot miss the sense that you are in a thriving city when you visit Melbourne, for example.
History may look back and decide that Donald Trump, with his ‘America first’ policy, was the politician to set in train the beginning of the end of globalisation. What are the likely consequences for businesses and regional equity indices? It will not have escaped your notice that the US equity market has outperformed the rest of the world over the past ten years, achieving a 14 per cent return vs 9 per cent. Research conducted by Elm funds founder Victor Haghani points to the fact that two thirds of this is attributable to superior earnings per share growth but the remaining third is explained by the fact that US stocks have become more expensive than those elsewhere.
Part of the difference in rating and performance can be explained by the larger component of higher-rated technology companies. The US market has 11 per cent more in technology companies than the world outside the US. This does not explain all the difference, however. It seems likely that the faster pace of buy-backs in the US and the fact that US investors tend to prefer to stay close to home are also significant factors.
The key questions appear to be: will investors continue to pay a premium to own US companies rather than non-US companies, and in a less global world will US companies be able to continue to deliver superior earnings growth? As we conducted our quarterly manager reviews for our clients over the summer, I took the opportunity to ask managers what their view was on this topic. Opinions were varied, but not many managers were prepared to wager on an end to US outperformance.
A recent McKinsey study analysed 6,000 of the world’s largest public and private companies with annual revenues of at least $1 billion, which account for 65 per cent of global corporate pre-tax earnings. These ‘superstars’ constitute the top 10 per cent of companies but capture 80 per cent of the economic profit. Although their diversity has increased, US companies still make up the largest share, with 38 per cent, compared to 45 per cent in the 1990s. Companies from China, India, Japan and South Korea now make up 22 per cent, up from 7 per cent. The McKinsey study argued that globalisation has not gone into reverse but has shifted gears towards a more data-driven, hemisphere-led trend.
While the centre of economic gravity may be shifting east and Asia is grabbing a larger share of the global economic profit, contrarians may continue to be wrong-footed for some time to come. The chances are that savvy investors will continue to hedge their bets by staying invested in the US and increasing Asia at the expense of an ailing Europe. It also seems likely that investors will continue to be prepared to pay a premium for the global ‘superstars’ wherever they choose to locate themselves.
Photo credit: CGP Grey @Wikimedia Commons
Annamaria Koerling is a partner at Owl Private Office LLP