Corporate earnings and investments set to diverge amid shrinking global productivity, growing gap between economies
While the long era of globalization boosted economic growth, generated jobs, and produced other economic benefits for both industrialized countries and emerging markets, current trends point to a slow unraveling in that trend – with profound implications for investors.
In a recent commentary, Regina Chi, vice-president and portfolio manager at AGF Investments, pointed noted how major governments are increasingly relapsing into protectionism.
China, the most important link in the current hyper-globalization network, has grown more forceful and less accommodating to Western goals. With its invasion of Ukraine, Russia has snubbed the so-called "new world order," further upsetting the already fragile global supply systems that the pandemic had already shown.
“Given the durability of globalization since World War II, it might be tempting to assume those are short-term trends,” Chi said. “But there is another possibility: that these are markers of a slow deglobalization that will mean higher inflation and a far less productive world for years to come.”
Pointing to previous bouts of deglobalization in history, she noted how the U.S. hiked tariffs after the First World War and again during the Great Depression. Each time, its trading partners retaliated with their own levies, leading to sharp declines in global trade openness in both cases.
More recently in 2018, tit-for-tat trade wars occurred between the U.S. and Canada, Europe, Japan, and China. Levies against Chinese goods – the so-called Trump tariffs in the U.S. – did not end with that administration in 2020, particularly as an anti-China trade stance enjoys bipartisan and popular support.
As China’s geopolitical positioning becomes more aggressive, including tacit support for Russia’s invasion of Ukraine, the Asian superpower is also waging economic war against the U.S. as it encroaches into the tech market.
The fallout of deglobalization for investors, Chi said, will be higher inflation. While multinational companies were previously able to raise productivity and profits by arbitraging tax rates, low tariffs, and low labour costs to EMs – including China – deglobalization threatens to undo those and other dynamics.
China’s growing distance from Western-dominated multilateral trade, coupled with a devastating global pandemic and Russia’s aggression against Ukraine, is prompting a rethink of the value of lean, just-in-time global supply chains among corporations and policymakers.
As deglobalization widens the divide between economies, Chi said, corporate fortunes and investment opportunities will go on separate paths.
“For investors, the potential for ‘higher-for-longer’ interest rates means a higher cost of capital for companies to service their debt and grow their business,” she said. “Just as investors will have to be selective on the country level, a focus on quality companies could prove critical for 2023 as the world potentially heads into a recession (sans China) next year.”