The Full Story:
This week, we lowered our stock market exposure across our global equity exposure from 100% to 90%. Our portfolio management discipline directs us to reduce risk levels at end-of-market cycles and increase them at the beginning. This does not indicate that we have lost wholesale confidence in the present market or this economy. However, our macro work indicates that mid-term downside risks now exceed the upside potential. We do not take hedging lightly and have no compulsion to try and frenetically time markets. We last applied hedges to our portfolios in 2007. Downturns that accompany recessionary periods create enough downside deviation to compensate for the inability to perfectly time tops and bottoms, making recessionary periods worth hedging. Lastly, our portfolio design enables us to hedge up to 40% of our overall market exposure, making this step only a partial step, and perhaps the only step….or perhaps the beginning of a more defensive campaign. Time will tell.
The Global Political Recession
Political anxieties across the globe have risen to historic levels. I will remind our readers that we invest in companies, not governments, making us somewhat immune to the typical hysteria over policy proclamations. Unfortunately, the current mix of global policy actions and rhetoric has congealed into a deglobalization directive for the world economy. Clearly, trade levels between the US and China have fallen, but Hong Kong and China have now gone to fisticuffs, and the UK seems poised to exit the Eurozone without an agreed upon plan. Meanwhile on the back pages, Italy, Latin America and the Middle East all struggle with populist uprisings. While there are no perfect indices for tracking globalization, comparing the level of world trade growth with world GDP growth makes a useful proxy:
Clearly, growth in trade throughout the 90’s and 00’s exceeded growth in global GDP as NAFTA and China’s entrance into the WTO reduced trade frictions significantly. However, since the Great Recession, governments have struggled with populist impulses arising from global wealth disparities encouraging reversal. This has led to a rise in nationalism and a new round of international resentment. Donald Trump didn’t create this balkanization. Donald Trump is a symptom of the disease. Intuitively and empirically, more trade makes economies more efficient and productive. Less trade makes economies less efficient and less productive. The current political energy devoted to deglobalizing the world economy isn’t new, it’s just a more bombastic continuation of a trend.
The Global Economic Recession
Recent economic data releases place Germany, Britain, Italy, Mexico, Brazil, Argentina, Singapore, South Korea, Russia and Hong Kong on the edge of recession. Macro-mavens will recognize that most of these countries rely heavily on exports for growth. Here are exports as a percentage of GDP: Germany (47%), United Kingdom (30%), Italy (32%), Mexico (39%), Singapore (176%), South Korea (44%), Russia (31%) and Hong Kong (188%). De-globalization hurts these countries a lot. In the US, we are somewhat immune, with exports accounting for only 12% of our GDP. From this perspective, Trump is right. Because the US economy largely feeds itself, walling off trade hurts others far more than us. Additionally, since the US consumer represents 70% of US GDP, if they remain employed, optimistic and consumptive, the US economy should continue to expand. However, the US only contributes 11% to global GDP growth. China provides 40% of all global economic growth and another 40% comes from emerging markets that largely sell into China. Therefore, a downshift in Chinese growth means a downshift in global growth.
The IMF recently downgraded global growth forecasts for 2019 and 2020 while warning of further deductions should trade tensions remain. Many assert that current economic concerns are overblown as the US consumer carries the global economy. Here is the math. The US economy represents 24% of global GDP. If the US consumer accounts for 70% of US GDP, the US consumer, therefore, accounts for 17% of global GDP. In my opinion, if China’s growth recesses due to trade deductions, their vendor economies will recess, corporate profitability in the US will recess due to higher input costs from labor and tariffs, employee payroll growth will slow, wage gains will diminish, and consumption spending will follow. In other words, I do not think the US consumer can “Atlas” the global economy and I see consumer spending as a lagging indicator anyway. If global economic momentum maintains its downward course, the US economy may lag…but it will follow.
Have a great Sunday!