We understand ‘protectionism’ as actions taken to control the movement of people (including skills and knowledge), capital, goods and services. It naturally follows that protectionism has economic, monetary policy and political implications which in turn affects financial market assets.
Protectionism affects both emerging and developed markets, in our view. Many Western countries and their population are experiencing a sort of “globalisation fatigue” and are rethinking previous policies that embraced the free movement of people, capital, goods and services. We think the globalisation fatigue is because globalisation, while having increased collective economic output, might have also contributed to economic inequality inside developed countries. Most emerging market countries are still keen to see more globalisation/less protectionism. But even some emerging market countries have taken a nuanced approach to globalisation i.e. are happy to open up some areas of trade in goods and services while slowly to open up their capital markets.
Political protectionism and the major developments in the past 1-2 years
There has been a political tilt towards protectionism in a number of countries - the Brexit referendum in the UK and the election of President Donald Trump in the US were the most powerful examples. Both were won on the basis of protectionist rhetoric and pledges to the UK and US population, to deliver stronger protection from foreign labour and corporate competition. The Dutch and the French election this spring saw conservative pro-market candidates win, to the relief of investors. However it is still notable that even these winning candidates did not run their election campaigns on the basis of an aggressive defence of globalisation. The Brexit referendum had a clear market impact: the average UK Sterling exchange rate dropped 9 percent in the first 24 hours after the referendum results were published (source: Bloomberg).
Economic protectionism and its subtleties
Economic protectionism can impact investors´ portfolios because it changes the rules by which companies and countries operate, altering the pathway of company earnings and GDP growth. However the impact will be difficult to quantify because economic protectionism has taken subtle forms and sometimes it has been disguised as creating new free trade partnerships. As an example, the TPP (Trans Pacific Partnership) spearheaded by former president Obama and dropped by president Trump, was promoted by the US as a set of free trade agreement between itself and 11 majors countries along the Pacific Ocean. The agreement could have, according to economists from the Petersen Institute, boosted US exports annually by more than USD 360bn and lift exports from the other signatories to the agreement. In spite this ostensible trade boost, the talks excluded China, leading one to conclude that it was also a project to curb China’s international economic reach. TPP was hardly therefore a model of globalisation. Explicit examples of economic protectionism (the ongoing Brexit negotiations and NAFTA re-negotiations) are still in their early stages. It is likely too early to predict what kind of rules governing the movement of goods, services, capital and people emerges from these talks. Consequently it is difficult to estimate the economic costs of these examples of protectionism.
Monetary protectionism and its boundaries
Monetary protectionism is another form of exercising control, albeit control of the movement of capital. China has been trying to strengthen its control over capital movement by its own citizens. Chinese companies and households have, in the last decade increased their exposure to international markets and have started to invest significant amounts of money in foreign equities, bonds and companies (The American Enterprise Institute estimated that between 2005 and 2016, China’s international investment in companies and construction reached USD 1.5 trillion). These outflows have weakened the Chinese renminbi and prompting the government in the last two years to try and slow the outflows. The Chinese government has encouraged Chinese state-owned companies to invest less abroad, strengthening the policing of regulations governing companies and individual’s investments abroad. The measures have had some success this year in slowing capital outflows but we doubt these measures will fully stop the outflows.
Finding new avenues
Some countries have found different paths around rising global protectionism. This is in particular true for the Emerging markets where new trade agreements are being finalized, certain economic sectors are being supported (in the advent of protectionism) and official efforts are being made to expand trade in existing regional markets. There are three trends in particular that investors could consider in their investment decisions when seeking to overcome protectionism.
First, investors can look to identify sectors that are naturally less prone to protectionism: for example commodity related equities have in the twelve months to May 2017 been doing very well compared to the industrial sector equities. This may be due to different commodity producers in the world have little or no competitors in the countries where the governments might be considering protectionist policy. If, for example, the US acts to block the import of rare metals from China, Tesla would struggle to make the motors and batteries for its vehicles.
Second, Emerging markets are moving to strengthen political and trade alliances with each other, with China and could start increase their exchange with Japan. China, has for many years been investing in Africa and has accelerated its investments in Latin America as well (investments in companies and in construction in Latin America by China has doubled in the three years to 2016 to around USD 20 billion per annum according to the American Enterprise Institute). This trend of investment is linked to trade with Latin America and can extend given that large Chinese companies have access to savings at home and are highly rated by S&P and Moody’s which facilitates cheap borrow on the international capital markets to fund their investments. The countries that can improve political ties with China and with other big proponents of free trade (such as Japan and Europe) may outperform in a climate of rising protectionism.
Third, another way for a country to boost GDP growth is for policy makers to focus on domestic consumption and create national champions. Asian countries have taken this approach in the past, with some state assistance for companies that focused on domestic consumption. In China, for example, state development banks have been supporting sectors that were once big importers, with Chinese companies using cheap financing from state owned banks to buy component companies for certain industries to give themselves a technological boost in manufacturing. This is nothing new as Japan followed a similar approach in the 1960s-70s and Korea in the 1980-90s. The electronics sector is littered with examples of one international brand being overtaken by another, and sometimes with some form of past state assistance. The television market, for example, saw Japanese corporate dominance in the international market overtaken by Korean counterparts. Mobile phones has also seen a similar leap frogging - Nokia suffered this when Apple released the Iphone, which in turn has seen its smartphone market share eroded by Korean companies such as Samsung and LG. Chinese companies such as Huawei and Xiaomi are making inroads into Korean market share. There are other examples of certain sectors growing with the help of some state assistance, initially do well with domestic consumers and then launching successfully in the international market place.
Investors should in their asset allocation decisions consider the impact of protectionism and how different countries and companies can circumvent protectionism. As has been outlined above, this can be done on an economic basis for select countries and on a sector basis as well.
Senior Macro and FX Strategist - Emerging Markets Fixed Income