Globalization trends that once drove economies and markets are in retreat. Ruchir Sharma looks at the key themes that are emerging as protectionism rises.
With the increase of the anti-globalization rhetoric in Europe and the U.S., little doubt remains that populism is on the rise—and protectionism with it. To Ruchir Sharma, Head of Emerging Markets and Chief Global Strategist at Morgan Stanley Investment Management, that means investors must re-evaluate the conventional wisdom about which companies and markets can outperform in a new world of populism and protectionism.
“The big point is that every single trend of the last few decades has been turned on its head by de-globalization,” Sharma argues. “Companies that were more externally oriented did quite well in the era of globalization, but now they may not.”
Here are some of the new anti-globalization effects and trends that could shape markets and economies in 2017 and beyond.
“In the past, rapid per-capita GDP growth was almost always propelled by rapid export growth,” says Sharma. “Now, globalization is declining, and we believe the economic advantage is shifting from traditional export powers like South Korea to countries with relatively low exports as a share of GDP and large domestic consumer markets, like India, Peru and Indonesia.”
With export revenues likely to decline in a new protectionist environment, investors should watch domestic revenue-focused corporations; particularly in countries where domestic consumption is the largest driver of GDP growth.
Many companies enjoyed strong profit margins by outsourcing low-end jobs. As borders close, the clout of multinationals goes down, the bargaining power of local workers goes up. Since 2012, the corporate share of U.S. national income has started to inch down, and the worker’s share has been moving higher. The rise of leaders like Trump, whose policies are designed to bring companies and jobs back to America, will accelerate this trend.
“Even if you get tax cuts and deregulation in the U.S., it’s unlikely that a Trump administration will achieve the increased productivity levels that were enjoyed during the Reagan era,” says Sharma. “During the Regan administration, growth in the labor force was 1.6% per year. Now it is 0.3%. People are getting older and families are having less kids, and this is why we think the potential growth rate for the U.S. will remain around 2%, and not 4%.”
“Before 2008, rising trade competition helped contain inflation, but de-globalization weakens that natural check,” says Sharma. He adds that wage pressure has been rising in the U.S. since 2011,1 and will continue to do so, if fiscal stimulus is introduced when the U.S., with a 4.8% unemployment rate,2 is operating at full employment capacity.
Populism is expected to continue spreading in a low-growth world with rising income and economic inequalities—but not in Latin America, says Sharma. “Latin America is one of our most significant overweights because the political cycle there is moving in a very different direction to the rest of the world. Latin American countries are still enforcing economic orthodoxy, after having already experienced the economic outcomes of populism.”
“The place to look for good news in 2017 is where it is least expected: Europe,” says Sharma. “Europe has already suffered two recessions within eight years, a rare double whammy that makes another downturn less likely, not more. European banks have also reduced their debt, which could set the stage for a new lending and growth cycle.”
“China continues pumping out debt to maintain growth, but it’s becoming less effective as time goes on,” says Sharma. “Before 2007, it took $1 of debt to generate $1 of GDP growth, but now it takes more than $4 of debt to produce the same result.” How long can this go on? “There are three metrics to watch. One is the loan-to-deposit ratio, now around 120%. The second is capital flows. The third is the interbank market, to see if funding is getting difficult. The worsening of these metrics will indicate when the debt game in China enters the endgame.”