Changing trade patterns may trigger portfolio shifts
A structural trend that has been brought into focus by Covid-19 is that of ‘deglobalisation’, which can have significant implications on portfolio decisions.
“Even before the US–China trade war, we saw businesses move their supply chains out of China and into countries closer to home, but that trend has been accelerated by the pandemic, as the crisis has laid bare the downside of having such a complex global supply chain,” explains Katherine Nixon, chief investment officer (CIO) of wealth management at US private bank Northern Trust. But choosing resiliency over efficiency is coming at the cost of lower margins.
Northern Trust expects lower equity returns over the next five years, both for US and non-US stocks, although emerging markets will still have a return premium. From Donald Trump’s ‘make America great again’ to Joe Biden’s ‘build back better’, both presidents have an agenda of putting America and its economy first, prioritising policies such as moving jobs back to the US and sourcing products and services domestically. “This is a global phenomenon which will manifest in less optimisation and lower returns as a result”, says Ms Nixon, acknowledging that the trend “has yet to be fully fleshed out.”
Lower returns are also a function of other structural headwinds which have been exacerbated by Covid-19, such as huge government debt loads. Challenging demographics will also weigh heavily on the economy, leading to slower growth.
Diversifying processes
Supply chains will be restructured and potentially duplicated for diversification purposes, says Tracie McMillion, head of global asset allocation strategy at Wells Fargo Investment Institute; however, this does not mean globalisation is going to diminish, it will simply change. Clients, who are generally overweigh US assets and specifically large caps, should keep exposure to international markets, both within equity and fixed income, as well as commodities, which is a global market.
Wells Fargo has a more negative outlook on international developed market equities, if compared to US or emerging market stocks. In particular, European markets are going to struggle with structural issues and are facing weakness in their economic data, owing to Covid resurgence and more stringent lockdowns. In the US, investors should have a barbell approach with exposure to both small caps, which will benefit in the early-cycle phase, as well as large caps, “as volatility could resolve in some movement back into higher quality names.”
Emerging markets are expected to strengthen due to resumption in global trade and “potential softening” of the US trade policy with China, while also benefiting from attractive relative valuations and weaker dollar. Moreover, the rise of commodity prices is going to positively impact commodity exporters.
Yet, fixed income is kept in most client allocations. “We do believe there is going to be a demand for fixed-income and income-producing assets due to ageing demographics,” says Ms McMillion. While high yield is preferred, portfolios maintain exposure to investment grade too, which is believed to bring stability to the value of portfolios during times of volatility.
Seeking out opportunities
The emergence of a multi-polar world, as economies become more self-reliant, is going to be “hugely beneficial” to some of the smaller economies, explains Bill Street, group CIO at Quintet Private Bank. The trade deals signed between China, Japan and all the South-East Asian countries at the end of 2020 are a clear example of self-encompassed demand circularity and supply chains. “Given the impact of the pandemic on trade flows, supply chains and the overall trajectory of globalisation, regional economic blocs will become increasingly influential over the next 10 years,” Mr Street predicts.
This should lead to new investment and diversification opportunities across geographies, likely playing out over many years. As the investment universe expands and major economies decouple, portfolio diversification will become even more important. “While it is too early to say how this trend will develop in the Americas — and Latin America especially because of Covid-19 — we would expect this trend to evolve. This is one of the reasons why we are positive on emerging markets, and especially Asia, in the longer term.”
