Republican presidential candidate and former president Donald Trump speaks at a campaign rally on May 1 in Waukesha, Wis.Morry Gash/The Associated Press
The world experienced a prolonged period of economic globalization from 1981 to the beginning of 2017. This period effectively ended when Donald Trump became president and began implementing an “America First” trade policy.
No matter who wins the White House this November, this deglobalization trend will accelerate. And this will have a profound impact on the investment returns of various asset classes for at least a generation.
Simply put, it will be the mirror image of the globalization era. Lower trade barriers increase economic growth. Conversely, this new protectionism will dampen growth. That is a negative for equity markets.
But not all equities will be equally affected nor will all economies. I have some suggestions on how investors can prepare.
First, a few words on how we got here.
The 1981 start date of globalization coincided with the Ronald Reagan presidency and the loosening of trade barriers, including the 1989 Canada/U.S. free-trade agreement and the 1994 North American free-trade agreement that added Mexico. China joined the world economy, producing cheap goods that were sold to companies such as Walmart, which drove down prices to North American consumers. Globalization seemed to provide enormous benefit to the world economy but in an uneven manner.
The bloom came off the rose for economic globalization after the 2008 Great Financial Crisis as the quarter-century golden period that began in 1982 ended. That boom was largely a result of a rise in international trade, deregulation, technological advancement, low inflation, low interest rates and some other factors including demographics changes.
As the post-2008 recovery turned out to be anemic compared to previous recoveries, many became disenchanted with the economy during the Barack Obama presidency. This resulted in the election of Donald Trump, Brexit and the rise of nationalist sentiment and parties in Europe. The U.S. working class believed globalization hurt America while Europeans saw their very national identities challenged by a tidal wave of migrants who strained the social safety nets of those nations.
The ratio of world trade to gross domestic product (GDP) was about 25 per cent in 1970 rising to about 61 per cent in 2008. It then fell gradually before rising in 2022. Deglobalization has occurred before. The previous era occurred between the onset of the First World War and just after the end of the Second World War.
We know from history that smaller and more open economies will struggle in this new environment. Smaller, less economically diversified economies that have high trade-to-GDP ratios will be challenged to maintain their growth rates. Even though smaller European nations have access to the larger economies on the continent, we are already seeing rebellious farmers demanding that the products of their neighbours be banned from their markets.
This trend massively benefits the U.S. in relative terms. It is a giant market, has a relatively low trade-to-GDP ratio, especially if you take out Canada which is an economic satellite. The U.S. can produce more food than it needs and is energy independent to an extent.
This is very bad news for China, which although large, relies on trade and seems to be resented by its major trading partners. Canada, as a small and open economy, is at risk but can benefit from its relationship with the U.S. Our destiny, to some extent, is in our own hands. If we carefully manage our relationship with our American neighbours, we can do well. If we continue to mismanage our position, we may endure grave economic consequences.
Economic growth will be lower. Price pressures will be higher. Interest rates will be higher. After coming off a prolonged period of artificially low rates, people will struggle to cope with this higher-rate environment. The cost of capital will be higher, and companies will have a tougher environment. Price/earnings ratios, already historically higher as shown by the Shiller P/E ratio, will decline significantly, which will affect stocks negatively. Bad for stocks. Generally good for bonds.
Less economic integration will cause cross-national equity correlations to decline, adding to the advantages of international diversification. Volatility will also increase. The era of high equity returns and low volatility is coming to an end. Good asset allocators will come back in style.
What is the investor to do in this new world?
There are some exchange traded funds (ETFs) worth considering. Bonds should do well, but I recommend a higher weight to U.S. Treasuries and to avoid currency hedging. Ten-year U.S. Treasuries yield about three-quarters of a percentage point more than similar-term Canadian bonds. Given that inflation in the two nations is effectively the same, and that the loonie is vulnerable because of Canada’s weaker economic growth, U.S. treasuries offer superior value. The iShares U.S. Treasury ETF. (GOVT-A) is well diversified and has low fees.
Small-cap funds tend to rely more on local markets than giant international names. They have underperformed and are better value. The Vanguard Small Cap ETF (VB-A) or the iShares Core S&P Small Cap ETF (IJR-A) are safe choices. I favour the U.S. market for small caps given its greater diversification.
Commodities will benefit from deglobalization. Nations that are not self-sufficient in food will have to pay dearly for agricultural imports. The populations of poorer nations in Africa, the Middle East and Asia are growing, and food demand will rise accordingly. Mineral prices will also rise with inflation and will likely rise by more than consumer prices. Furthermore, because of environmental concerns, new mines will continue to have a tough time getting regulatory approval, and this will constrain supply. First Trust Global Tactical Commodity Strategy Fund (FTGC-Q) should be entertained. It is actively managed.
Industrial real estate investment trusts and consumer staples will also benefit in a deglobalized environment.
Deglobalization is here to stay. Invest looking forward and avoid the rear-view mirror.
Tom Czitron is a former portfolio manager with more than four decades of investment experience, particularly in fixed income and asset mix strategy. He is a former lead manager of Royal Bank of Canada’s main bond fund.
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