Jean-Pierre Couture makes the case for top-down investing in an era of ‘de-globalisation’
Over the past several decades, the world experienced a phenomenon often referred to as ‘globalisation’. But it is much easier to collaborate in times of prosperity than in times of austerity. Following the financial crisis, co-operation is now giving way to competition in a countertrend that we call ‘deglobalisation’.
During the ‘Great Modreation’ since the mid-1980s, the depth and frequency of economic cycles were subdued through better economic policies, more efficient global markets and accommodative monetary policies. With inflation under control, central banks now had the ability to smooth out economic cycles by reducing interest rates as soon as growth started to sputter. In other words, a way was found to avoid or shorten recessions by encouraging households to immediately consume their future income. Particularly since 2000, this unprecedented credit cycle in developed countries boosted global demand. China went from marginal player to the world’s second-largest economy. Millions of workers emerged from poverty and joined the ranks of consumers, adding fuel to an already strong global demand.
But the negative side effect in developed economies was the accumulation of tremendous leverage at every level, culminating in the massive bubble whose bursting resulted in the 2008 financial crisis.
The globalisation trend resulted in a new market phenomenon. Equity returns among developed countries were falling into a narrower range compared with their historical pattern: the alpha potential from country selection diminished. But from now on, the global economy is not strong enough to act as a tide that lifts all boats. Many economies have lost their shock absorbers: we can no longer avoid or shorten recessions by lowering interest rates, or afford stimulus programmes. It’s the end of the ‘Great Moderation’.
As the world enters a period of deleveraging, economic growth in developed economies will likely be much more muted and volatile. The weakness of developed countries will also affect emerging nations, which are now integrated in the global economy.
The relatively small dispersions in country returns that have prevailed since 2000 are likely to give way to wider differences. Governments and central banks are adopting various approaches and policy mixes just to get by. Some are already entering into currency wars, while others are backing away from free trade: between the G20 meetings of 2011 and 2012, more than 226 restrictive measures on international trade have emerged. The competitive devaluation strategy adopted by Japan’s central bank is a good example of this ‘deglobalisation’.
As such, in the years following the 2008 financial crisis macroeconomic factors have become major drivers of market returns. Since the 2008 crisis, world markets have tended to move ‘in-sync’ in response to macroeconomic news. We analysed two periods for which we had comparable data pertaining to the influx of economic news and the resulting market returns: 2003-08 and 2008-12. The correlation between market returns and economic news, almost nonexistent between 2003 and 2008 and negative in emerging markets, has been high since 2008.
This underscores the role top-down investing can play as a diversifier in portfolios dominated by traditional bottom-up analysis. In the deglobalisation era, generating alpha will require recognising and managing events such as trade wars, currency devaluations, and wider disparities between winning and losing countries. There will undoubtedly be other periods of euphoria and other crises, some global, some regional, some concentrated in a couple of sectors. Clearly, this environment will provide ample opportunities for those who fully understand its dynamics and what is at stake.
Jean-Pierre Couture is economist and strategist for emerging markets at Hexavest