Globalization reshaped the world economy over the past four decades, linking countries through the free flow of capital, people, and goods to bolster growth and—at least in theory—engender geopolitical harmony. Along the way, it built China into an economic powerhouse, pulled more than a billion people out of poverty, and created a burgeoning middle-class hungry for U.S. goods.
As the world grew closer, U.S. companies tapped low-cost labor abroad to create efficient global supply chains, reducing the need for warehouses filled with inventory and contributing to record profits and a free flow of cheap goods that helped keep a lid on inflation.
Much of that is now in question. U.S.-China tensions, the pandemic, and Russia’s invasion of Ukraine have exposed the risks of global integration. China’s ascent into a formidable economic and geopolitical rival has pushed the U.S. to increasingly view its relationship with the world’s most populous country through a national-security lens.
That has been compounded by pandemic-related disruptions. U.S. hospitals are rationing X-rays and CT scans because of shortages in chemicals, in turn caused by factory shutdowns thousands of miles away.
Apple
(ticker: AAPL) has warned that it could take as much as an $8 billion hit to sales in the current quarter as China’s zero-Covid policy interrupts supply chains and dents economic activity. India and Turkey are banning exports of grains and agricultural products as the war in Ukraine exacerbates food security concerns.
“For years, companies operated on the belief that periodic tensions with China or Russia wouldn’t disrupt critical supply chains covering goods, energy, metals, and minerals,” says Myron Brilliant, head of international affairs at the U.S. Chamber of Commerce. “That assumption is no longer the case,”
Globalization 2.0 will take shape over years, but the early contours are already visible, with more companies and countries stressing safety and resiliency over cost and efficiency as they look to diversify and duplicate supply chains around the world.
A byproduct, at least in the short term, could be more trade as companies build up inventory as buffers. Even with the trade war, export restrictions that blacklisted some Chinese companies from U.S. technology, and supply-chain disruptions, global trade hit a record $28.5 trillion last year—13% higher than in prepandemic 2019.
In the long run, Globalization 2.0 is likely to be less lucrative for the private sector as governments direct a larger share of investments, often on national-security rather than economic grounds.
“The economic costs are going to be real,” says Adam Posen, president of the Peterson Institute for International Economics. The result, he says, will be “lost opportunities,” lower returns on investment, and increased volatility.
That volatility could mean opportunity for investors in companies that are facilitating this shift by helping countries become more self-sufficient in critical areas such as semiconductors, or building production closer to home or in friendlier destinations.
Shares of many of these companies could get even cheaper in the coming months as the market digests recession concerns and the broader shifts at play. U.S. equities are baking in earnings growth for the next decade that suggests little change—even as the forces that boosted corporate profits are now challenged, says Rebecca Patterson, chief investment strategist at Bridgewater Associates, who sees reason for caution.
BlackRock CEO Larry Fink warns that the end of globalization as we know it is near—and could bring higher costs and margin pressures.
Whirlpool
CEO Marc Bitzer recently told analysts that the appliance giant was trying to reposition itself for a “new reality” of geopolitical tensions, freight cost inflation, and increased trade barriers as a result of the decoupling of global economies.
Big changes are ahead in areas linked to national security—including semiconductors and the rare earths critical to tomorrow’s technologies. Congress is expected to pass a China package this summer that includes money for more domestic semiconductor production and incentives to bring manufacturing of critical goods home—or at least move production to friendly countries.
Semiconductors are the lifeblood of the global economy, and Taiwan Semiconductor Manufacturing sits atop the chip industry
Courtesy of TSMC
China is moving to shore up its own technology and food security, as well as reduce its reliance on the dollar following the West’s sanctions on Russia. China is banning senior officials of the Communist Party and their families from holding real estate abroad or shares in companies registered abroad, The Wall Street Journal reported this past week.
| ETF / Ticker | Recent Price | Net Assets (mil) | YTD Total Return | Comment |
|---|---|---|---|---|
| iShares MSCI India / INDA | $40.50 | $4,900 | -11.2% | India is an increasingly attractive manufacturing destination that could benefit as companies look to diversify beyond China. |
| iShares MSCI Mexico / EWW | 49.66 | 845 | -2 | Near-shoring trend should help Mexico’s economy broadly as companies are drawn to its low-cost labor, strong manufacturing base, and proximity. |
| iShares Global Industrials / EXI | 102.58 | 313 | -16.9 | More than half invested in U.S. companies, 14% in Europe. It could be volatile as recession fears mount but well positioned for longer term. |
Sources: company reports; FactSet.
Barring a Chinese invasion of Taiwan, a decoupling that completely unwinds globalization is unlikely, considering the deep financial and economic ties between the U.S. and China. Exports to China represented about 858,000 U.S. jobs in 2020. More than 300 congressional districts have 1,000 or more jobs supported by those exports, according to the U.S.-China Business Council.
“The winners of this coming wave of globalization will be India and Southeast Asia. Everyone wants to invest there.”
The latest survey by the American Chamber of Commerce in China indicated that about half of respondents delayed or decreased investments because of the latest Covid outbreak. Just 14% of businesses surveyed last year by the U.S.-China Business Council reported moving any part of their supply chain out of China. But strategists expect more new investment beyond China as companies look for regional alternatives and countries form regional blocs with like-minded nations.
Parag Khanna, founder of global strategic advisory firm FutureMap, says the U.S. is well positioned for this next wave because it is relatively self-reliant on multiple fronts. At the same time, he sees the center of gravity in trade moving east.
China accounts for 15% of global exports, nearly twice that of the U.S., and is the largest trading partner for just about every major country. China also sits at the center of the world’s largest trade bloc—the Regional Comprehensive Economic Partnership—which includes Japan and Indonesia, plus a dozen other countries.
Countries are hesitant to pick sides, even as the U.S. begins a campaign to bolster its Indo-Pacific alliance and form closer relationships with India and Southeast Asia.
“The winners of this coming wave of globalization will be India and Southeast Asia. Everyone wants to invest there: There’s a growing middle class and a more open society and democratic ways not found in China,” Khanna says. “They are in the sweet spot of geography, geopolitics, and demography.”
The transition to Globalization 2.0 promises to be gradual and messy, but investors can use the recent global market selloff to identify winners and recalibrate their assumptions about profits, economic growth, and returns.
Three funds and nine companies serve to illustrate the investments in the sweet spot for the upheavals to come.
| Company / Ticker | Recent Price | Market Value (bil) | YTD Total Return | Forward 12-Mo. P/E |
|---|---|---|---|---|
| Elgi Equipments / 522074.India | INR328.85 | $1.3 | 10.1% | 50.5 |
| Prologis Property Mexico / FIBRAPL14.Mexico | MXN51.50 | 2.2 | -7.4 | 12.9* |
| DSV / DSV.Denmark | DKK1.098.50 | 35.1 | -27.8 | 16.5 |
| SMC / 6273.Japan | JPY65,970 | 33.6 | -14.4 | 22.3 |
| Kennametal / KMT | $26.35 | 2.2 | -25.6 | 12.9 |
| Taiwan Semiconductor Manufacturing / TSM | 90.53 | 469.5 | -24.5 | 15.4 |
| KLA / KLAC | 333.85 | 49.8 | -21.9 | 14.0 |
| Kingdee Int’l Software Group / 268.Hong Kong | HK$14.96 | 6.6 | -37.7 | NM |
| Silergy / 6415.Taiwan | NT$2,925 | 9.3 | -41.5 | 31.6 |
*Price-to-funds from operations. NM=not meaningful
Source: FactSet
India’s size, young workforce, and democratic system put it in an attractive spot as companies seek alternatives to China. India is stepping up efforts to become more competitive for manufacturers, cutting taxes and offering incentives to bolster its “Made in India” push, says Matthew Dreith, associate portfolio manager of the Wasatch Emerging Markets Select fund.
The
iShares MSCI India
exchange-traded fund (INDA) is a broad-based way into the action. Indian industrial companies are another, including air-compressor maker
Elgi Equipments
(522074.India), which is poised to take market share as companies seek alternative suppliers. It should also see increased demand as companies build duplicative supply chains around the world. Air compressors are widely used in manufacturing plants. Elgi’s valuation—50 times forward earnings—looks pricey, but Dreith says that long-depressed spending is picking up. That should boost margins, and the company’s heavy investments in Europe and U.S. should begin to pay off.
Low labor costs and an established manufacturing base should drive investment into Mexico from U.S. companies looking to bring its suppliers closer to home. While a slowdown in the U.S. could weigh on Mexico, in the longer term, the
iShares MSCI Mexico
ETF (EWW) offers a way to tap increased investment in the country.
Inside a Taiwan Semiconductor Manufacturing wafer factory in Taiwan.
Courtesy of TSMC
Another beneficiary:
Prologis Property Mexico
(FIBRAPL14.Mexico), a $2.2 billion real estate investment trust that manages logistics and warehouses, and estimates that 30% of its manufacturing demand came from near-shoring last year. Increased near-shoring, along with growth in e-commerce and supply-chain disruptions, should help the company generate double-digit earnings growth for some time to come, says Matthews Emerging Markets Equity manager John Paul Lech.
Another promising area is emerging as governments look to become more self-reliant. China has laid out a road map of its priorities, with plans to generate 10% of its gross domestic product from the digital economy by 2025, making semiconductors and software critical to its goals. Sung Cho, senior manager for Goldman Sachs Asset Management’s Fundamental Equity, favors local companies like
Kingdee International Software Group
(268.Hong Kong) and semiconductor makers like Taiwan’s
Silergy
(6415.Taiwan).
The sharp selloff in Chinese stocks amid concerns about the economy and Beijing’s Covid shutdowns left these stocks trading at a 30% discount to global peers, despite similar growth rates, says Cho.
Semiconductors are the lifeblood of the global economy—a reason that China and the U.S. are intent on bolstering chip manufacturing at home. Demand for chips is also growing. Electric vehicles require double the number of chips that traditional cars do.
Taiwan Semiconductor Manufacturing
(TSM) sits atop the chip industry, with a more than 50% market share of global semiconductors and 95% share of 5-nanometer technology crucial to innovations in areas like artificial intelligence, 5G, and other technologies of tomorrow.
The company has been built for resilience, a byproduct of sitting in a geopolitical hot spot and managing relations with customers around the globe. It is building a $12 billion fabrication plant in Arizona and another plant in Japan, and is considering building plants in Singapore and India. At 15 times forward earnings, Taiwan Semi trades below its five-year average, as the sector is hit by concerns of a global slowdown and supply-chain disruptions.
“They are sensitive to U.S.-China tensions and changing world order and are planning around it—and are still in an extremely strong situation, which the market is unable to price properly,” says Jenny Davis, co-manager of Baillie Gifford’s International Alpha Strategy, which oversees $18.3 billion. The company’s dominance and three-year plan for $100 billion in capital spending is on a “monumental scale. No one else can compete.”
Cho favors semiconductor capital-equipment makers, which are selling at about a 25% discount to the S&P 500 index.
KLA
(KLAC) is one of the biggest beneficiaries of the buildout in leading-edge chip capacity. The company’s stock price has baked in recession fears but not its long-term potential.
The changing nature of global trade could also spark an industrial revolution as companies build new manufacturing hubs or turn to automation to defer the higher costs of shifting to pricier destinations. Industrials are vulnerable to fears of a global recession, but Elias Cohen, head of the international equity team at Neuberger Berman, sees the volatility as a good time to identify companies that are focused on electrical goods, robotics, and machinery, and are well positioned for the next decade.
The
iShares Global Industrial
ETF (EXI) is a broad-based way to tap the sector. Another beneficiary: Japan’s
SMC
(6273.Japan), which holds a roughly 45% global market share in pneumatic controls used in manufacturing and has strong pricing power. After selling automation-related stocks last year as valuations got too rich, Cohen has started to add some back in the recent selloff. SMC, for example, trades at 22 times forward earnings, below its five-year average.
Kennametal
(KMT) is a U.S. beneficiary of Globalization 2.0 as efforts to build resilience in supply chains, especially around energy and critical minerals, increase demand for the company’s tools, dyes, and bits used in infrastructure projects and oil-and-gas exploration. It sells for 13 times forward earnings.
Charlie Bobrinskoy, who manages the focused value strategy at Ariel Investments, says the price bakes in a recession, even though he puts the recession odds at 50/50. He says the price doesn’t reflect the company’s longer-term prospects from a new phase of globalization.
Freight forwarder
DSV
(DSV.Denmark) does best when trade patterns change. The Danish company reported a first-quarter net profit that exceeded what it earned in all of 2019. DSV’s capital-light business model churns out cash flow, and management has a strong record of savvy capital allocation and consolidating the industry, says Baillie Gifford’s Davis. Analysts expect the company’s earnings to rise 25%, to $2.2 billion, or $9.70 a share, on top of a 81% increase last year. “The friction of change pushes customers to outsource their organization of freight transport,” says Davis.
The transition to a new type of globalization will come with its share of disruption. That boosts the case for diversification, not just for companies with their supply chains, but also for investors with their portfolios. The latest market upheaval is a good time to start.
Write to Reshma Kapadia at [email protected]
