The TEXPERS Blog

Headed Down the Rabbit Hole? Maybe Not

Threat to globalization must be acknowledged, 

but history suggests it won't be derailed

Credit: iStock

By Michael Reynal

Guest Columnist

Chinese President Xi Jinping recently traveled to the World Economic Forum in Davos and championed the benefits of globalization while highlighting the risks of protectionism. Meanwhile, populists in Britain and the United States—stalwart nations of global free trade—have been busy talking up the scourge of globalization. It’s an upside-down world only Lewis Carroll would understand.

Indeed, globalization is in the cross-hairs of many politicians. Threats of tariffs and protectionism abound, and, if enacted, they could pose a drag on global economic growth. Nobody correctly predicted the political outcomes of the past year, and certainly nobody knows how nationalism will manifest itself in future trade policies. Yet there is a feeling that more sensible minds will prevail and globalization is, ultimately, unyielding. Moreover, any setbacks and subsequent market volatility might provide opportunities for active managers who can capitalize when stock prices disconnect from fundamentals.

History as our guide

I fully acknowledges that there are very real risks to globalization today. But as an equity manager with a global perspective, I still believe in trade liberalization and its ability to lift both developing and developed countries. Statistics from the World Trade Organization show a longer-term trend of rising international trade following the conclusion of World War II between 1950 up until the global financial crisis in 2007-2008. There may be setbacks along the way, but I think the slowing pace of trade liberalization and rising protectionism rhetoric is unlikely to completely reverse globalization.

Ultimately, globalization is driven by four key factors: cross-border capital flows, trade, migration, and the free-flow of ideas and communication. Capital flows and trade may have hit a speed bump, but migration and the exchange of ideas and knowledge continue unabated. In fact, the era of digital globalization (the vehicle of increased knowledge-sharing) is still in its infancy. A 2016 report from McKinsey Global Institute asserts that in contrast to slowing international trade in recent years, digital flowsare showing no signs of abating. Cross-border bandwidth “has grown 45 times larger since 2005,” and “is projected to grow by another nine times in the next five years,” according to the report. All of this is boosting participation in the global economy and suggests that globalization is not reversing.

Risks remain

Yet, in recent years, globalization has resulted in uneven economic growth among nations, as well as disruptions across various sectors of the economy. This is the reality, and it may be fueling the recent rise of populism and nationalist rhetoric. There has been heightened talk of protectionism, and, surprisingly, much of it is emanating from the West. This includes rumblings from the new U.S. administration of a 45 percent tariff on Chinese goods, or a border adjustment or“mirror” tax for goods produced in Mexico. No doubt about it, if enacted, these types of protectionist measures could create short-term pain for global investors.

Once protectionism grabs hold, it runs the risk of spawning new tariffs, weakening consumer confidence, and elevating geopolitical tensions. Consumer costs could rise while supply chains are disrupted, resulting in job losses that could continue in a disturbing feedback cycle.

The takeaway

That’s just one possible dystopian economic future, but the likelihood of such a bleak scenario is a long-shot in my opinion. There’s simply too much to be lost on all fronts. In China, for example, the Central Authority must hold up its half of the tacit agreement whereby Beijing continues on a path to economic liberalization (albeit not always as quickly as hoped) in return for stability, peace and control. The U.S. and other developed economies are also unlikely to launch into full protectionism at the risk of hampering economic growth.

In times like these, it’s incumbent upon investors to retain their longer-term focus and commitment as to why they are allocating to emerging markets. That may be to capture potential higher rates of growth, to diversify return streams, or even to diminish their inherent home-country bias. Moreover, emerging markets often tend to over-react to macroeconomic developments in the short term, and this can provide opportunities for active managers.

As emerging markets investors, we’ve been dealing with challenges for more than 16 years, so we take the latest protectionism “threats” in stride and are confident that we will continue to find ways to uncover opportunities in fast-growing and exciting developing markets.

The views expressed herein do not constitute research, investment advice or trade recommendations.

Michael Reynal

About the Author:

Michael Reynal is chief investment officer of Sophus Capital and a portfolio manager of the Victory Sophus Emerging Markets Fund, Victory Sophus Emerging Markets Small Cap Fund and Victory Sophus China Fund.