CIO Thoughts: Can Portfolio Managers Invest in a De-Globalized World?

So why, exactly, is the very framework of the global economy changing for the first time since the late 1970s? Broadly speaking, one answer is that global deficits have simply become too high to sustain any longer. Public sector debt exceeds GDP by a factor of more than 250% in many Western economies, including the United States. A recession in an economy with such widespread debt could lead to a collapse of global financial infrastructure. To solve this, countries will need to balance out the debt-to-GDP ratio; the most effective way to do so is raising prices to inflate the growth rate of nominal GDP. An environment like this is not completely unprecedented – this is what happened in the wake of World War II – but it would certainly represent a challenge for investors who have only known years-long bull markets. Another driver is the complicated relationship between the US and China which is a discussion for another day.

According to many proponents of the phenomenon, the most consequential economic implication of deglobalization would be systematically elevated inflation. Economist Russell Napier posits that over the next fifteen to twenty years, as capital investment booms amidst widespread Western reindustrialization, the economy will be marked by vicious cycles of financial repression and stagflation³. This would throw a wrench in the system most investors have grown accustomed to for the better part of the past half century; the era of combatting inflation with additional stimulus dollars could be coming to an end. Ultimately, this would signal the end of a four-decade long era of investing that Napier calls the “free-market era,” as he argues the process of deglobalization will move the economy to a system where governments largely control the allocation of resources.

So how can investors capitalize on deglobalization and use the phenomenon constructively to build their portfolios? American reshoring is a byproduct of deglobalization and figures to be a familiar topic in the years to follow. Manufacturers are moving their production back to United States shores; the main factors which drove these companies to offshore have grown more costly and hard to maintain. Offshoring labor for a fraction of the price seemed like an infallible business model, but corporations are starting to realize the hidden costs of maintaining inventory from such a distance. Unreliable and slow transportation to the United States, added security fees, and negative supply shocks have effectively annulled any additional profits attained from offshoring jobs. The cause has been bolstered by politicians and common folk alike; reshoring has received nearly $2 trillion in unprecedented bipartisan political support, while it gains traction among consumers due to their positive perception of goods made in America.

Of course, one could capitalize on deglobalization by simply purchasing domestically orientated US equities, infrastructure, manufacturing, or the like. However, the ramifications of deglobalization figure to be even more far-reaching than this. Reshoring will most notably benefit the infrastructure industry as corporations build more plants on American soil, but other industries — such as process automation, access systems, and technology distribution — should also reap the financial benefits. Small caps (particularly industrials) could also act as a good investment, as they are strongly domestically inclined by nature. Their tendency to exhibit more sensitivity than their large-cap counterparts also means that small caps are more poised to take advantage of revenue growth driven by reshoring. Lastly, a portfolio of materials, industrials, commodity equities, and natural resource stocks should benefit from a deglobalized world that brings manufacturing back to the US.

Another topic that comes into play is the effects of onshoring on inflation. Our view has been consistent for some time now. We thought inflation would remain stickier and higher for longer, and that has proven to be the case. The Fed recently increased interest rates at the fastest speed in nearly half a century and CPI/PCE still remain higher than before the COVID-19 pandemic. Will the Fed continue to hike to bring inflation back to 2% and threaten throwing the entire economy into a recession? Only time will tell. In the meantime, we think portfolios will benefit from an allocation to inflation linked assets to weather the inflation storm, deglobalization, and onshoring in the coming years.

Best,

John Davi

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¹ https://kof.ethz.ch/en/forecasts-and-indicators/indicators/kof-globalisation-index.html

² https://www.brookings.edu/bpea-articles/is-the-global-economy-deglobalizing-and-if-so-why-and-what-is-next/

³ https://themarket.ch/interview/russell-napier-the-world-will-experience-a-capex-boom-ld.7606

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