The fact that the people in the UK and the US, two countries that have been at the forefront of liberalism – intellectually and politically speaking – have now spoken out so loudly against the status quo, is an indication of how exhausted the current regime is. It is also not coincidental that the pioneers who enjoyed the benefits of globalization earlier are the ones that have hit the end of the road first.
What will this imply from a world order perspective? Probably that domestic politics will overturn international relations and supra-national coordination efforts in the years to come. Forget about the Fed looking after the global economy, the US Treasury bothering to rescue foreign countries, not to mention for funding the IMF or the World Bank.
Revolving against the global order on your own à-la North Korea is not a clever thing to do, but once the Hegemon retreats, other countries will start to follow suit. The next cracks will probably occur within the EU, which is starting to look like a vestige of a bygone era. Sooner or later another core country will leave, and in my opinion it is just now a matter of time until an exit strategy is commonly agreed. Political risk is hence on the rise, and with the referendum in Italy and elections in the coming months in Austria, France, Netherlands and Germany, betting for a mean-reversion to normal times is a risky strategy.
What will this mean for investments? Probably the end of the great moderation period, inflation on a the rise due to both the reintroduction of trade barriers, tariffs, quotas, and the promotion of local industry, accompanied with larger fiscal deficits to finance the transition into a new model. It is also highly likely that we will witness another metamorphosis of the exchange-rates regime, putting and end to the era of freely-floating currencies that replaced the Bretton Woods system. This may actually be the area where most efforts for international coordination will be spent, and as a result the attractiveness of gold as a market-driven alternative currency will probably be restored.
All these structural changes will naturally translate into higher interest rates, and a lower return on equity, as labor costs and financing costs will both increase, whilst global economic growth – in real terms – will decrease, which will be detrimental for equities, credit and long-duration bonds. This is also bad news to emerging economies, which have been one of the biggest winners of globalization.
It is difficult to identify bright spots – besides inflation-linked bonds – but the new global arrangement may mean good news for workers and domestic industries in developed countries, the more protected they are, the better. Examples of these are local companies in strategic services like energy, utilities, defense, construction and consumer staples.
In conclusion, we need to be aware that we are going to be living in a restructuring phase, and similar to what happens in every corporate turnaround, there will be a cost associated to it. Globalization will not end, but it will be repriced, and it is important to bear in mind that this process is starting at a juncture in time when most asset classes are very richly priced. Our final investment advice then would be to increase caution until we have better visibility on the speed, amplitude and direction of this transition, as from where we sit today, there is a much greater potential to lose than to win by embracing risk.
Fernando de Frutos, MWM Chief Investment Officer
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