Losers from deglobalisation

Globalisation is under threat. President-elect Trump’s call for protectionism, plus the likelihood of a hard Brexit, pose the danger that world trade will contract.

In truth, though, politics isn’t the only threat to world trade. The ratio of world trade volumes to industrial production has flatlined since 2008 according to figures from the CPB. This means that the trend since the 1960s for trade to grow faster than output has ceased.

There are several reasons why this has happened. Difficulties in managing long and complex supply chains have stopped companies from outsourcing more, and led some to ‘reshore’ production. And rising wage costs in China have reduced the country’s attraction as the workshop of the world.

It’s possible, therefore, that political forces against globalisation will merely reinforce economic ones.

Investors should worry about this, because deglobalisation would be a threat to share prices.

For years, there’s been a strong correlation between the All-Share index and world trade volumes (of 0.6 for annual changes in the two since 2000) with each percentage point of slower trade growth knocking an average of 1.5 percentage points off annual equity returns.

Now, this itself isn’t proof that deglobalisation would hurt equities. It might simply tell us that global economic downturns are bad for them.

But there’s something else. There’s also a strong link between equity returns and annual changes in the ratio of world trade to industrial production. Since 2000 each one percentage point faster growth in world trade relative to output has been associated with 2.5 percentage points higher annual equity returns.

There’s a simple reason for this. The ratio of world trade to output can be seen as a measure of the global division of labour, with a higher ratio indicating increased specialisation and hence trade. And as Adam Smith famously wrote in 1776, the division of labour causes “the greatest improvement” in our prosperity. It should therefore be associated with higher share prices. And it is.

This poses the question: if we do see deglobalisation, which stocks would be the biggest losers?

My table might shed some light on this. It shows the sensitivity of some FTSE sectors to the ratio of world trade to industrial production, based on annual changes since 2000.

This shows that mining stocks are most sensitive to globalisation. We should, however, be careful in interpreting this. It reflects the fact that China’s entry into the global economy boosted demand for commodities, and that the country’s stagnation – which contributed to a slowdown in world trade – hurt miners hard. This doesn’t mean miners would be hardest hit by the political backlash against globalisation.

Banks and general financials, however, are another matter. These have benefited more than most from globalisation and might perhaps lose from its reversal.

Common sense tells us why. If a company is the best in the world at what it does, globalisation is great news for it as it can sell its products around the world rather than just in its home market. If, however, a firm is so mediocre that its products are unattractive to overseas buyers, being limited to its home market won’t hurt it, and, in fact, it will benefit from diminished competition from foreign rivals.

This tells us that the biggest UK losers from globalisation would be those companies that have the greatest comparative advantage which they are currently exploiting globally. Many of these firms are in the financial and aerospace sectors.

This poses the question: will any stocks benefit from deglobalisation?

Maybe not. The only FTSE sector with a negative correlation with the world trade-output ratio is pharmaceuticals – and that is only marginal.

Perhaps this shouldn’t surprise us. If a company is big enough to be in the All-Share index it is doing a lot right. It should therefore have some sort of comparative advantage which enables it to benefit from easy access to global markets. To this extent, any retreat from globalisation would be a danger for very many stocks.

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