July 16th, 2019 | by Gregg S. Fisher, CFA, "Invest with Reason"
Investing in a World at Odds
• Globalization—not for the first time in history—is under siege.
• Stress is emanating from rising populism around the world, growing income inequality, and the surge of China.
• Global economic growth is slipping, while global debt is mounting.
• Investors will need to take more risk to achieve a targeted investment return.
It’s a messy world out there. Global economic integration is under siege; populism is on the rise; China is surging; Britain is getting a divorce from the European Union; politics in the US are remarkably polarized. To try to make some sense of this global discord, Gerstein Fisher hosted an event entitled, “A World at Odds: Investing in an Era of Brexit, the Mueller Report, and the Rise of China,” on May 14, 2019. I spoke about some of the challenges the current environment presents for investors, following a talk by Harvard Business School Professor Rawi Abdelal on fraying political and social relationships around the world.
Abdelal, who is also Director of Harvard’s Davis Center for Russian and Eurasian Studies, began by tracing the historical ebb and flow of globalization (measured by the extent of market integration for goods, services, and capital across the borders of sovereign states). As illustrated in Exhibit 1, the period from 1870 to 1914 marked the first great era of globalization, which was destroyed by World War I and then failed to recover (until 1980, really) due to the stock market crash of 1929, financial chaos and the Great Depression in the 1930s (which triggered trade protectionism emanating from the US), and devastation from World War II. Today, globalization is again facing disruption from forces such as left- and right-wing populism, levels of income inequality that are incompatible with social solidarity, and a great-power transition (i.e., the rapid rise of China).
To Abdelal, Brexit is a good example of fraying social and political ties. The Brexit movement reflected fear of globalization, of pan-Europeanism, and of immigration, and was abetted by rising income inequality and a very low level of intergenerational economic mobility in the UK. The referendum vote in 2016 revealed a sharply split society, with younger, better-educated and skilled workers voting to remain in the EU, and older, less-educated citizens with a generally dim view of immigration and multiculturalism voting to leave the EU. The US, he notes, has similar voter polarization and, as brought home by the reaction to the Mueller Report, polarized Americans now almost dwell in alternate realities and cannot even agree on what is true and what is not true.
Politics, Trade, and Investment
I addressed some of the investment challenges tossed up by this messy world. The global economy is slowing, with a wide dispersion of growth rates (see Exhibit 2); and growth has, unfortunately, been accompanied by a rapid accumulation of debt during the past decade (global debt-to-GDP is currently nearly 3:1, a record). In addition, low interest rates and relatively high market valuations imply that, to achieve a given target portfolio return of, say, 7.5%, investors will need to take far more investment risk (as measured by expected portfolio volatility) than in the past. This presents a particular dilemma for retirement savers; for more on this important topic, please see my recent article, “The Retirement Investment Challenge“.
Political headlines (e.g., Brexit and trade wars) are spooking investors, but we also need to distinguish between temporary distractions and fundamentals and long-term investing discipline. For instance, Britain’s struggle to come up with a Brexit plan is disconcerting, but that shouldn’t prevent one from investing in UK-listed global companies that serve customers around the world. Trade friction between the US and China has certainly generated uncertainty, but many businesses have ways of adjusting to new challenges by, for instance, moving production from factories in China to Vietnam or India.
I have barely scratched the surface of what we discussed at our May 14 event. For more detail on the content of our discussion, I invite you to read an extensive recap of the event that we have produced.