Over the past 30 years, three forces have largely been responsible for relatively high global GDP growth. First, interest rates have steadily declined since the highs of the 1980s, providing a constant and strong tailwind to the global economy and causing virtually all capital assets to rise in value. Second, the Internet and other new technologies have caused productivity and efficiency to increase substantially and for information to be shared more easily across the globe. Finally, at the center of these forces, globalization, exemplified by the creation of the Eurozone, the European Central Bank, NAFTA, and the World Trade Organization, has removed many barriers to international trade. This has allowed capital to flow more freely across borders, increasing avenues for trade and commerce and introducing sellers of goods to a new pool of buyers.
While these three forces have contributed to relatively strong investment returns over the past 30 years, each is under pressure and, as a result, investors should expect future returns to be somewhat lower than in the past.
We believe that investors are relatively familiar with the first two forces. The first force, declining interest rates, should not be expected to continue. Global rates are at or near historical lows with a move higher seemingly inevitable (although the timing of that move remains uncertain). Second, the Internet has permeated commerce to a substantial degree, potentially limiting the future growth of the technology sector, which has been a key driver of global equity returns.
Of concern, we are now starting to see the third force break down. Many developed nations responsible for the globalization trend of the last several decades are moving towards nationalistic postures that threaten to limit or reverse the easy flow of capital across borders. We believe investors need to understand this move from globalization to a “New Nationalism” and how it could affect their portfolio returns.
The New Nationalism
The emergence of nationalism is well exemplified by “Brexit” and the potential breakup of the European Union. We have long been concerned with structural challenges that the EU experiences primarily due to the disconnect between centralized monetary and decentralized fiscal policy. These growing nationalist tendencies, magnified by the recent refugee crisis, are producing an environment wherein countries begin to seriously consider leaving the union. The UK took this theoretical risk and made it a reality with the vote for “Brexit.” While the political dynamics that led to this event are fascinating and complex, we are perhaps even more interested by the fact that the markets clearly did not anticipate the UK leaving the EU. Despite the fact that the event was clearly a product of these growing tendencies, global markets are still reacting as if Brexit is a “one-and-done” event. We can’t help but wonder which country might be next? While support for leaving the EU appears relatively low in many large nations such as France and Germany, support in the UK also appeared relatively low for a long time before the vote.
More concerning is that the nationalism trend is not just limited to the UK or even the EU. The rise of Donald Trump as a presidential candidate in the U.S. (among other populist and far-right candidates, globally), imperialistic motivations of China in the Sea of Japan, and Russia’s aggressive moves in Ukraine and Crimea all serve as further evidence of this global trend. If the trend towards globalization does indeed reverse, barriers to trade may re-emerge, and capital flows may become restricted. This would cause global GDP growth to slow, which could drag investment returns down.
This environment leaves investors with the important question of whether to prepare for a prolonged period of relatively low global growth and low returns. While this story will play out over the next decade, we believe it is wise for investors to reassess their long-term objectives, understanding that the relatively high returns experienced over the last 30 years may not continue for the next 30. We do believe, however, that this environment may present opportunities for investors to capture relatively attractive risk-adjusted returns by taking advantage of potential market volatility (i.e., buying during sell-offs) and focusing on fundamentally sound investments in private markets.