Our global strategist says we could be at the tipping point of a shift away from globalization and deregulation toward populism and protectionism, which could have important implications for investors.
Politics has always been part of the narrative of investing, and just underneath the surface lies an ebb and flow of influences that can direct politicians and their policies. At our recent Investment Forum in Frankfurt, we considered some of the many factors that are keeping politics at the top of investors’ minds today – like the Brexit decision in June, the US presidential election in November and Italy’s upcoming referendum. As we took a closer look, we found that these events may not be part of the usual tide of relatively unrelated political occurrences; rather, they seem to be connected by a longer-running and deeper momentum.
Consider that from 1980 through to the Global Financial Crisis (GFC), the world witnessed a clear political trend toward globalization, deregulation and closer international cooperation. This trend benefitted consumers globally as traded goods prices fell – albeit at the cost of hollowing out many domestic manufacturing industries – and it helped big multinational companies that could capitalize upon and optimize their selling prices and logistics.
The “winners” of globalization were mostly multinational corporations and mercantilist economies and companies in Asia, particularly in China, where wages were low and the ease of competition and technology transfer high. The “losers”, on the other hand, were the lower- and middle-class workers and domestically oriented businesses in the developed world that could not match these imported prices. For decades, governments competed to attract multinational companies and their investment power, even though they contributed little save for employment and offered local economies only a small amount of value added. This dynamic helped fuel the debt-funded global consumption boom as trade surpluses were recycled back, and it contributed to the growing wealth effect for those not hurt by globalization – a phenomenon that has accelerated with the integration of the internet and mobile telephony that now rests in consumers’ hands.
A political tipping point
Today, however, there is much evidence that we are seeing globalization slow if not reverse, leading us to believe the world may be at a political tipping point:
- The Brexit vote and themes raised in the US presidential race suggest that many voters in the developed world feel the markets no longer work for them, and that the benefits of globalization have been offset by its weaker wage and employment prospects.
- Multinational companies appear to have been gaming the global tax system, with the result that they have no obligation to pay taxes on goods and services as they play one government off against another.
- The weak, dull economic growth seen since the GFC has not created wealth and welfare for many parts of society – and government bureaucracy and outdated labour legislation have made matters worse.
- A growing number of millennials – those born after 1985 – are already burdened by high education loans and poor job prospects, and they are becoming increasingly disenfranchised by democracies that concentrate on satisfying their Baby Boomer parents – creating a source of inter-generational tension.
- The “haves” and “have-nots” have always been part of human history, but today’s rising levels of economic and forced immigration have denied wage increases to local workforces and lowered living standards. This has added to a growing sense of wealth and income inequality, fuelling nationalist fears and populist politics.
De-globalization’s implications for investors
While much remains uncertain in the realm of politics, it is now clear that the former trends of globalization and deregulation have slowed or are in danger of being reversed. Once any trend like this has started, it could last for some time, if history is any guide. Consider that the last prolonged period of globalization culminated in the Great Depression in the 1930s and the Smoot-Hawley trade tariffs in the US, which did not get redressed until the early 1980s by President Ronald Reagan. Of course, while it may be too soon to say what the exact effects of this political trend will be for investors, we have identified a few early implications:
Less global trade means less global growth
Politicians are rowing back on several major global trade agreements currently under discussion, such as the Trans- Pacific Partnership and the Transatlantic Trade and Investment Partnership, which will inevitably add grit to the global gears. With global trade constituting approximately 40 per cent of global gross domestic product, this could slow economic growth at a time when it is already fragile. If global trade were an economy, it would be the largest in the world – nearly twice the size of the US economy – but it is rarely viewed in this way by policymakers.
Corporate responsibility must be redefined
Many multinational corporations have benefitted from decades of globalization, especially in terms of trade and finance, but this could eventually become a headwind if politics increasingly favours local brands and forces local taxation. More immediately, the recent Apple/European Commission tax rulings could increase inter-regional tax friction, which could hinder the allocation of capital and reduce returns to shareholders. The world does not need more friction; remember how protectionism became a key theme in the 1930s, when the world tried to stabilize after a previous period of globalization. For our part, we at AllianzGI are committed to engaging with management teams and governments to ensure that corporate responsibility is viewed in the widest manner possible – beyond just earnings per share or tax revenues.
Fiscal spending should be fiscally responsible
Dull levels of economic growth may be met with growing calls – such as those heard this past summer – for more fiscal and infrastructure spending, though there should be mounting concern over the affordability of such outlays. Enormous investments are certainly needed in the big economies of the future such as India, Indonesia and Africa, not to mention the repair and maintenance needed in the developed world. Yet rather than be funded by more borrowed money, these investments must both cover the cost of financing and add to these regions’ economic prosperity and productivity. If not, they are simply Ponzi schemes.
Keeping promises is expensive
Soon, politicians in the developed world will have to confront the cost and financing of their welfare states, or risk seeing their millennial children revolt against honouring the unfunded promises made to their parents. These structural reforms are currently eluding demographically challenged areas such as Japan and much of Europe, and the longer these challenges are left unanswered, the bigger they will become. Indeed, even in the US, the current outstanding debt-to-GDP level of 100 per cent is dwarfed by the promises on the books that are yet to be accounted for – entitlements that add up to more than 500 per cent of US GDP, or USD 130 trillion.
The Western world view may be fading
Immigration and the recent rise of radical Islam across Europe and Central Asia will create more political tension in the foreseeable future – tension that may sustain higher levels of populism and nationalism than any we have experienced since World War II. The secular Western perspective of the modern world, under Pax Americana, is ending and being replaced by a return to an older-world version of countries and states that predates the WWII-era solutions imposed by the US and the UK. This revision is also taking place in a region full of oil and replete with many long-standing histories and frictions – another example of today’s political trends connecting in a new way with the politics of the past.
Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.
The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.
This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations.
This material is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission (SEC); Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; and Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator; Allianz Global Investors Korea Ltd., licensed by the Korea Financial Services Commission; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.
With extreme monetary policy and political uncertainty making it hard for investors to find returns, Neil Dwane highlights how short-duration bonds offer the potential for higher returns today and reduced volatility when rates rise.
At our recent Investment Forum, we reconfirmed AllianzGI’s long-standing view that in today’s environment of central-bank repression, investors must take risks to earn returns. Yet while some have indeed enjoyed decent performance from their risk investments in recent years, there is still uncertainty about the changing political landscape and the distorted world of zero and negative interest rates. Negative rates have so far caused many investors to lose money, while merely low rates have failed to help investors adequately protect the purchasing power of their savings.
The risk of navigating difficult terrain with longer durations
While no one knows for certain how long this environment will last, it is becoming increasingly clear that global economic growth could remain slow and interest rates low for a very long time. This has forced some investors to take more duration risk in the form of owning traditional bonds with maturities of 10, 20 or even 30 years or more. The danger here is that the prices of these long-duration bonds will fall when interest rates rise, thereby causing a loss of capital.
Investors who own traditional bonds with long-term maturities risk watching their prices fall when interest rates rise, causing a loss of capital
Other investors try to mitigate this risk by seeking higher returns from longer-term investments in traditional equities or in illiquid alternatives such as infrastructure equity and debt, which can have investment horizons that stretch out 30 years. While these investments can be attractive alternatives to long-dated traditional bonds, their time horizons may be too risky for those who need shorter-term returns and income potential. After all, this is a marketplace of heightened volatility, elevated asset correlations and low returns warped by monetary policy – an uncertain dynamic that our financial repression thesis suggests could last another decade or more.
Negative Yields Are Spreading Around the World
Central banks have pushed many government-bond yields into negative territory to drive investors into riskier assets
Chart shows percentage yields of government benchmark bonds. Past performance is not a reliable indicator of future results.
Sources: Bloomberg, AllianzGI Global Capital Markets & Thematic Research. Data as of 4 October 2016.
Three reasons to consider actively managed short-duration strategies
Regardless of whether investors believe interest rates will remain “lower for longer” or feel a rate hike is imminent – though in our view, rate hikes are still unjustified in most of the world – short-duration investing can offer investors an appealing combination of attractive return potential and reduced downside volatility. Short-duration strategies have a broad opportunity set to capitalize on, including corporate debt, floating-rate notes and government bonds. Active managers know how to navigate this opportunity set to help investors exploit credit and illiquidity opportunities that exist across the US, Europe and emerging markets – without forcing them to take excessive duration risk.
Short-duration investing offers attractive return potential and reduced downside volatility
1 Insightful research gives active managers an advantage
With bond markets distorted by extreme monetary policy, most government bonds offer little in the way of attractive yields, forcing investors to look to the corporate sector for income potential. A strong, active investment process can be a benefit in this sector, as can the addition of insightful research from equity and bond research analysts who work together. Their combined analysis can enable portfolio managers to consider the entire capital structure of a company – both debt and equity investments – to find the healthiest balance sheets and the most attractive combination of risk and reward.
2 Enhanced income potential and flexibility mitigates uncertainty about inflation
Short-duration strategies do more than help investors guard against interest-rate hikes. Inflation is another real threat: It can spike unexpectedly, and even low levels can erode the real value of investors’ portfolios over time. The flexibility afforded by short-duration strategies can be a helpful addition in times of uncertainty while still providing attractive return potential. Moreover, with new regulations encroaching upon traditional sources of shorter-term capital within banks and money market funds, short-duration strategies offer a useful means of disintermediating these regulatory risks to earn an attractive spread over similar short-duration cash assets.
The flexibility and return potential of short-duration strategies can be helpful for fighting inflation
3 Active managers can optimize the risk/return ratio in changing markets
With their ability to assess changes in interest-rate policies, economies and the health of corporate balance sheets, managers of short-duration portfolios can move up and down the yield curve to optimize return and risk, and to capitalize on credit opportunities that arise in volatile markets. These advantages are only available in actively managed portfolios, as passive indexes are simply static baskets of securities that cannot adapt to changing circumstances.
The hunt for income is growing more urgent
Interest rates are at historically low or even negative levels, and today’s already-extreme monetary policies are continuously evolving – including “yield curve control” in Japan and a likely extension of quantitative easing in Europe. That makes hunting for income an urgent priority for many investors, and they will need to look beyond conventional bonds to find it – particularly when inflation can quickly turn low yields into negative returns.
Even if investors do not need to access their investment income today, adding income-generating securities to a portfolio can smooth volatility and supplement capital appreciation over time. We believe investors would be wise to look to active short-duration strategies to earn incremental returns and add diversification while guarding against serious drawdowns on their capital.
Duration is a measure of a bond’s interest-rate sensitivity expressed in years. If rates were to rise 1 per cent, a bond portfolio with a duration of 10 years would be expected to lose 10 per cent of its value as it adjusts to the new interest-rate environment. By contrast, a 1 per cent rate hike would cause a portfolio with a duration of 1.5 years to lose 1.5 per cent of its value. Duration risk is on the minds of many bond investors because interest rates and yields are so low; eventually, central banks will raise rates, which will cause a loss of capital as the bond’s value declines. In times like these, many investors look to shorten the duration of their portfolios to make them less sensitive to interest-rate hikes.
Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security. The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted. This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations. This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission (SEC); Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; and Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator; Allianz Global Investors Korea Ltd., licensed by the Korea Financial Services Commission; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan. | AGI-2016-10-05-16515