SANDSTONE’S view for the next 10 years - “The Next Decade” - was introduced at OUTLOOK 2019. This view was intertwined with a long-term secular change (40+ years) - creating a new cycle opposite from the last.
The topics we believed would have the most profound impact were:
1) Deglobalization
2) Connectivity
3) Demographics
What we did not anticipate was that geopolitics would trump everything.
Fast-forward three years…We are entering a multipolar world where geopolitics play an influential role in asset allocation and must be factored into investment decisions.
This shift has been affecting – and continues to affect – all markets, sectors, and currencies. We are witnessing major impacts and their knock-on effects on the US dollar, Treasuries, Energy, Agriculture, and Industrial markets.
From what companies and countries can sell to whom, to what currencies are acceptable, to where goods can be manufactured, and with what inputs are now critical components in investment overlays. Trade flows and international relationships are being redefined, and geopolitical tensions are accelerating deglobalization.
Globalization created an environment where goods were made and purchased cheaper internationally than locally, reducing inflation. International cooperation aided competitively priced commodities and pushed green objectives. It also degraded workers' bargaining power as there was always someone else that could do the job.
Globalization and international trade were viewed as a source of growth for low-cost countries and as a source of increased purchasing power for high-cost countries – muting inflationary pressures.
Would deglobalization not have the opposite effects?
We are now seeing countries take multi-headed action; prizing sovereignty over multilateralism, national interests over international cooperation, and local constituencies over global populations.
- OUTLOOK 2019
This is not new! Throughout history, there have been three main supercycles:
1) The pre-WWI era combined the Gold standard with “corporatism”
2) The post-WWII “mixed economy” era (the “Golden Age”)
3) Post-1980s “Neoliberalism”, which gained traction with Reagan, Thatcher, etc.
There is a definite secular change in inflation. Central banks will fight it, but they can not stand in the way of deglobalization and the underlying deep structural changes.
International goals of reigning in inflation without killing the economy are lofty, the best-case scenario is a soft landing. Even a mild recession is not going to eliminate current worker shortages or push real rates back to zero.
To top it all off, the US dollar has had a parabolic rise! The unrelenting strength of the US dollar to multi-decade highs has clearly been a major disruptor to global markets. Some say this is due to its safe-haven status and geopolitics today. Others say that is just the tip of the iceberg and a symptom of deglobalization. We do know that at these levels it will continue to be a major disruptor.
This is already happening as two of the world's biggest commodity importers (China and India) have been and will continue to shift their commodity bills from US dollars to their currencies. Over the long term, this will be a game-changing development, as demand for US dollars will start to decline.
The environment is changing to a multipolar/multicurrency world and the new supercycle will continue to have profound impacts on financial markets. The good news is that TINA (There Is No Alternative) is no longer in play; as interest rates rise investors will not be forced out the risk curve for return.
Despite the volatility in markets, there are pockets of positives. Singapore, India, Indonesia, and Brazil are all flat or up year-to-date in local currency terms. There are places to go, but currency matters.
SANDSTONE Investment View
1. The national security of resources will be a priority for all countries. We believe that the losers of the past decade will become the winners of the next and will likely be in the areas of ‘Feed the World’ & ‘Fuel the World’. Commodity-related securities will have enhanced returns.
2. Demographics matter. Approximately 75% of the world's population – 6 billion people – live in an Emerging Market country. This is a primary driver of global growth, wealth accumulation, and the world’s largest reservoir of future consumers. These same countries are forging new economic ties and cooperating for future growth. We believe Emerging Markets growth will outperform Developed Markets.
3. Inflation is structural and will remain higher for longer. The tailwinds of globalization are receding, and localization cost pressures persist. Government regulations will exacerbate cost pressures. Localizing factories or reshoring businesses will increase costs and reduce cost competitiveness in the absence of automation and government incentives (taxpayer dollars).
4. Global technology platform companies will continue to face headwinds from local governments – primarily around data, information, and advertising. Technology platform companies are also most exposed to US dollar headwinds, as the majority of their revenues are overseas. Growth at any cost is no longer acceptable and peak growth may have been reached, thus reducing valuations back to historically normal ranges. New leadership will replace the recent dominance of the technology sector.
5. The secular bull market in bonds has ended and a new secular bear market in bonds has started. As fixed-income yields return to the historical long-term average, we believe that short-term investment-grade fixed-income instruments will provide opportunities.
6. On all accounts, the US dollar is significantly overvalued, and, as with everything overdone, it will likely revert to the mean. As non-US investors, the risk of even a partial reversal to the mean can eliminate any positive investment performance – taking the US market off the table currently. We prefer the home currency advantage, as well as countries that have currencies that could help, rather than hinder, performance.
7. We believe that buy and hold ETF/Index capitalization-weighted strategies will underperform over the long term. Investors will need to be exceedingly more selective with passive strategies. Not all companies are created equal – financial stability (conservative debt) and real earnings growth will be rewarded. Adjusted earnings vs. real earnings are currently at extremes – a sign that peak profit margins are here.
8. Creative disruption will prevail. We believe that significant areas of focus are alternative energy, automation, infrastructure, 5G, longevity and gene therapy, and cyber security. All areas fit within the long-term secular shift and SANDSTONE’S Mega-trends of Deglobalization, Connectivity, and Demographics.
9. Market volatility is the new normal.
bottom line
In other words, we believe everything the markets were in the last cycle, they won't be in the next. The main difference today when compared to history is that geopolitics now play a more influential role in asset allocation. Opportunities are starting to present themselves in a very different way. Investors will need both patience and flexibility. Stock picking and identifying the right sectors will be the keys to success.