Rather like the sandwich-board men proclaiming “the end is nigh”, who seemed to be ever present on the nation’s High Streets until well into 1980s, the worst warnings over a possible ‘end to globalisation’ have yet to come to pass.
It is true that trade flows have taken some very serious hits in recent years from the pandemic, the war in Ukraine, and rising tensions between the US and China over the fate of Taiwan. But the net result of this, so far, has been to showcase the relative resilience of some tenets of globalised markets: for instance the manufacturing cheap electronics in China and shipping them via Amazon to, eventually, Budleigh Salterton.
All the same, an unsettling trend is clear. In essence, many aspects of the global economy suggest we are slowly turning back to a world of trade dominated by spheres of influence and monolithic economic blocs.
At the very least, there could now arrive an unnerving period where the previously unhindered, secular growth of global trade could instead become cyclical, uneven, or even stagnant.
If that proves the case, there will be consequences for investors. If there are now limits to the theory of comparative advantage – the idea that lower cost producers automatically have an advantage over peers - how will this be reflected in the way the stock market values companies, particularly those who have stretched themselves across the globe?
The great US reshoring
A basic truth about markets in richer countries is that genuine earnings growth is often generated somewhere else, and that this equation depends to a lesser or greater degree on the globalised trade in goods and services. But in the US, for one, there are moves being made in the opposite direction – and the impression is that this will principally impact industries with significant strategic importance.
Investors should be under no illusions that the reshoring of production, processes and distribution is already happening in the world’s major economy. This is being prompted by a combination of geopolitical fears over intellectual property theft – the US government recently announced a ban on selling microchips to China that can be used in the development of artificial intelligence, an area where the Chinese have built up considerable expertise - and companies’ own attempt to deal with supply chain issues.
Economists have started to quantify the impact the reshoring trend will have on jobs and investment. For example, Barclays economists caused a stir recently via research showing that US companies had already moved the equivalent of 350,000 jobs back home, primarily from Asia. To put that change into perspective, in 2010 the equivalent figure was 6,000. In fact, the term “reshoring” was mentioned 12 times as often during the last quarter’s US earnings calls compared with the same period in 2021. This is backed up by announced investments in domestic US enterprises, helped by recently enacted incentives for tax breaks on R&D investment. Companies such as Micron (US:MU) and Nvidia (US:NVDA) have both announced multi-billion capital investments in former rust-belt States. For these types of industries, the need to make supply chains shorter amid an uncertain international political environment has become more urgent.
On the other hand, whether companies can realistically afford to pay a three, or four times as much in wages for an American worker to do the same job is a pertinent point. That is partly why there has been a huge surge in sales of industrial robots alongside the reshoring trend. According to the industry group the Association for Advancing Automation (AAA), the first quarter of 2022 saw the largest ever number of industrial robot sales in the US, with over 11,500 units sold worth a total of $646mn (£547mn). The AAA says the trend started during the depths of the pandemic, when capital goods companies had to find ways to overcome supply bottlenecks and shutdowns in Asia to keep supply chains running. In other words, it may well be that jobs are coming back to the US, but it will be robots rather than humans that perform them. That could play to the advantage of companies like Ametek (US:AME), which offer automation services to businesses in a range of sectors.
This shift also fuels the great debate over whether the reshoring trend will have much of an impact on the overall US economy. For the past 40 years, the US has exported jobs to Asia in search of cheaper labour and higher margins. Yet reshoring has the potential to create large-scale investment opportunities. The question then for investors to consider is whether this will provide a significant boost to productivity and efficiency or, at best, be a net neutral for company earnings.
One point of note here is there might be ancillary benefits for other companies within the US economy. Analysts at Bank of America calculate that the current repatriation of revenue caused by reshoring amounts to an annual increase in capital investment for US companies of $37bn, with a knock-on effect for job creation in other industries (see table). In other words, the economic impact is all about companies re-establishing an ecosystem of supplier and client relationships in the home economy, which could have more impact than the mere fact of inward investment itself.
The implications for stock market investors are twofold. Firstly, the incentive to remain invested in the US economy in some form becomes more significant in a world of shorter supply chains. Secondly, if reshoring leads to fundamentally greater efficiencies in manufacturing practices as a result of needing to keep costs down, then looking outside the highly rated technology sector for value buys is going to be a greater source of returns.
Key automation players
There might even be ways for UK investors to play the reshoring trend for without going outside the comfort zone of the FTSE. For example, Renishaw (RSW) is the latest precision engineering company to report that the rush towards automation is having a positive impact on the bottom line, with the last set of results showing a near-20 per cent rise in sales as companies upped capital spending aimed at improving automation and efficiency. The share price is enduring a hangover as a result of a failed sale bid last year and the forward price/earnings rating for 2023 of 18 looks attractive compared with its five-year average of 31.
Investors with a certain taste for overseas adventure might look to Japan for an interesting source of returns. Japan usually gets attention for the relative cheapness of its market in comparison with the Dow Jones. But while the Nikkei is also relatively dull and mature, there are still some interesting players that could benefit from a trend towards home production and shorter supply lines.
The Japanese excel at marketing automated process and producing industrial robots on a grand scale. There are several big players but one of the more interesting from a valuation perspective is Keyence (JP: KYCCF), a long-standing electronics company with specialisms in all areas of automation. The share price trades on a forward PE of 38, well below its five-year average of 48: the pandemic and market rout this year have taken their toll on the share price. As with all Japanese companies, do not expect to earn a decent income as the dividend is a miserly 0.4 per cent, despite the fact that it has over $8bn of ready cash at hand. Still, it is in the right industry at the right time.
Germany’s Chinese takeaway
If America is worried about dependence on China, then Germany is currently going through a foreign policy nightmare that exposes many of the fundamental assumptions made by its political, economic and diplomatic leadership as deeply flawed. While the country’s fatal dependence on Russian hydrocarbons has been underlined by the war in Ukraine, the less public, but equally problematic trade relationship with China is also under the spotlight. The issue is so pressing for the Scholz government that it is currently conducting a total review of Germany’s relationship with China.
While clearly the US and China are the most obvious military adversaries in the Pacific, in economic and investment terms Germany is arguably the market most directly exposed to both the Chinese economy and the potential fallout there.
The rise of Germany’s trade relationship with China over the past 20 years has generally been seen as a relationship of mutual benefit. German engineering excellence in areas like machine tools, chemicals and automotive equipment meant China could recycle profits from making cheap garden furniture into developing and building a high value manufacturing base. German companies banked the profits and were able to expand industrial manufacturing capacity at a time when similar industries were in retreat in most European countries – there is sometimes an advantage to being the last to leave the party.
What started out as a profitable trading relationship has turned into something far more comprehensive – and increasingly worrisome for policymakers – in that German companies have made considerable inward investments in China as part of their trade strategy. As you would expect, these tend to cluster around the sectors in which Germany excels: chemicals, engineering, car manufacturing and high precision instruments and tools. In fact, according to official statistics, Germany’s total share of foreign direct investment in China went from 2 per cent of GDP in 2000 to 16 per cent last year, or €61bn (£51bn), with the automotive industry alone sitting on €24bn of investments in the country. There are an estimated 5,000 German firms with a significant presence, co-partnership stake or direct investment in China.
Despite high-level misgivings, the trend for German companies investing in the country seems to be accelerating, rather than decreasing in the face of political uncertainty. According to figures from the German Economic Institute, German companies invested €10bn in China in the first half of 2022, exceeding by some magnitude the previous high of €6.2bn. Ironically, China’s own dependence on Germany is decreasing as the increasingly sophisticated local manufacturing sector substitutes the high-quality finished products that German companies have traditionally exported. Against that background, it therefore makes sense for German manufacturers to double down on their investments in China as a way of keeping profits flowing, without the need to move the goods across the oceans.
In many ways, it could argue that this side-effect of globalisation is another example of its logical end state, where dependency emerges from relative economic weakness. It has probably also had a negative impact on how Germany’s economy has developed.
The current economic structure means is that lot of the country’s productive potential is tied up in capital intensive and low growth precision engineering and heavy industries, which is reflected in the manufacturer-heavy nature of the Dax. The reasons for this emphasis on manufacturing and heavy industry aren’t hard to fathom. The starting rate for a newly qualified automotive engineer - someone whose education and technical background might lend itself to founding a high value internet venture, for instance – is €80,000 with pension, health insurance and 8 weeks holiday a year thrown in. If a dominant industry such as automotive decides that it can pay top dollar to attract talent to ultimately service the needs of its Chinese customers, then the incentive to work in more esoteric, uncertain, but fundamentally more profitable industries is limited.
Times they are a changing
It is this combination of dependence and political instability that is keeping the current German government awake at night. At the first whiff of grapeshot over Taiwan, German companies risk seeing vast investments stranded in China, with the real possibility that secondary sanctions imposed by the US could devastate the country’s trade. German foreign minister Annalena Baerbock, who has taken a far more combative line towards Russia and China than many of her contemporaries, recently disavowed almost everything her predecessors stood for in one of the more important policy speeches of recent years.
“We cannot afford to stick to the credo of “business first” approach to trade without the long-term consequences of dependency being taken into consideration,” she said. There was even an allusion to how US corporations are reacting to changes in China. “Not without good reason is Apple shifting some of its production to Vietnam.” In short, Germany’s companies have been warned that they are on their own if things go wrong in the Middle Kingdom, and nudged towards the concept of ‘friend-shoring’ – the principle that production, if it can’t be reshored, should at least sit in an ally’s economy.
Battery farming in Somerset
Baerbock is also concerned about strategic supplies of Lithium, demand for which is expected to soar as more batteries are produced for electric cars over the next 20 years. Which brings us to the UK.
Whatever the merits of surrendering a frictionless trade advantage with several of its biggest trading partners might be, the UK’s current economic policy is a study in how the competing forces driving and forcing back globalisation can have unexpected consequences if countries decide to go it alone in certain areas.
Governments everywhere have already figured out that battery production and control of raw materials used to make them is fast becoming the equivalent of hydrocarbon security in the 20th century. This was why the UK government offered huge incentives, including bespoke planning permission, for Amazon-backed US battery company Rivian (US:RIVN) to build a gigafactory on a specially constructed campus near Bristol. Despite months of negotiations, the plans are reportedly now on ice – not over the protests of determined nimbys, but because of uncertainty over the use of personal data and Rivian’s commercial position in relation to the European Union.
Rivian’s financial disclosures have previously flagged the risks arising from the UK’s determination to change General Data Protection Regulation (GDPR) rules. Free marketeers have long argued that Brussels’ legislation, particularly the Digital Services Act, is too costly and bureaucratic – some estimates put the long-term cost of implementing the legislation at €31bn for the eurozone. The problem for the government is that diverging from the EU’s standards by too wide a margin will mean the EU revoking the UK’s information adequacy status, thereby ceasing the flow of data.
That is a big issue for a company like Rivian, as the UK to an extent still retains its status as an access point for exports to the EU; the lower level of social legislation makes setting up here cheaper than in France or Germany. Even post-Brexit, around 55 per cent of total car production in the UK goes to EU countries – and while it might seem counter-intuitive, an electric vehicle and battery manufacturer collects large amounts of personal data for marketing and business development purposes. Therefore, any threat that Brussels will staunch the flow of data from the EU via the UK to the US is considered a very serious business risk, which explains why Bristol may not be getting its plant. In other words, common standards still matter, even at a time when trade barriers are returning.
‘Never the twain shall meet’
A lot of the business case for large companies rests on these predictable standards, well-enforced regulation, and a general conformity of approach. But one other area where problems can arise is when globe-bestriding companies suddenly find themselves with internal competition between faster and slower growing units - often emblematic of their underlying geographic base.
HSBC (HSBA) is fast becoming a case study in how a business can struggle when its internal contradictions prove too great. On the one hand, the bank is well on the way to allocating 50 per cent of its total capital to customers in Asia (for this read Hong Kong and China) where margins and growth rates are higher. The old UK business is reliable, but with nowhere near the same rate of growth, and shareholders may wonder whether the solution is to split the business and remove the "globalised company discount" that arguably applies to the bank’s shares: the exposure to China is less attractive now the country's crazed infrastructure and property bubble bursts spectacularly in real-time, while Beijing’s increasing belligerence risks HSBC getting caught up in a geopolitical stand-off between Far East and West.
Nor is it just globalised companies that are finding limits to the benefits of globalisation. There is evidence UK businesses large and small have been bringing production back to home in recent times. A study from manufacturing trade group Make UK published earlier this year found that 42 per cent of British companies had increased their number of domestic suppliers in the past two years, with a similar proportion saying they intended to make further moves in this direction prior to 2024. Notably, the survey was conducted prior to Russia’s invasion of Ukraine – in this regard it is significant that almost 80 per cent of companies said they had already experienced disruption as a result of rising energy costs, which were cited as the third most significant disruptive factor after the pandemic and Brexit.
The consequences of these shifts won’t necessarily prove negative for investors, but they do require careful consideration. Risks like the above, once hypothetical or even unimaginable, can no longer be ignored. While the death of globalisation has been hailed many times over the past twenty years, most companies have not really been paying much attention. There is a sense, though, that this time it is different - and that overriding concerns over the potential for conflict and other factors are forcing companies to rethink how they manage their supply chains in the name of security, and, by extension, for the sake of profit.
