PEAKING GLOBALISATION, RISING POPULISM ARE A RISK TO THE GLOBAL ECONOMY

Transcription

1 MACROSOLUTIONS PEAKING GLOBALISATION, RISING POPULISM ARE A RISK TO THE GLOBAL ECONOMY JOHN ORFORD PORTFOLIO MANAGER JULY 2018 Globalisation has been one of the defining trends of the world economy since the Second World War (WWII). In the aftermath of WWII, the West sought to bind major countries together through multilateral agreements promoting international cooperation and trade. One outcome was a significant expansion in global trade. However, the Global Financial Crisis (GFC) in 2008 appears to be the high-water mark in globalisation. Since then, global trade's share of world GDP has declined. The recent escalation in Donald Trump's threat to increase US tariffs has gone hand-in-hand with a rise in populism in Europe, the United Kingdom and the United States. Former US Foreign Secretary Madeleine Albright recently commented: (This) is how twentieth-century Fascism began: with a magnetic leader exploiting widespread dissatisfaction by promising all things. History never repeats, but it often rhymes. In this article, I explore the evolution of global trade and populism and look at the similarities between the current period and the experience between the two World Wars. While it s still too early to call an end to globalisation, a retreat into protectionism by the US is clearly a significant risk to the global economy. GLOBAL TRADE TAKES OFF IN THE 19TH CENTURY One of the outstanding features of the global economy over the past two centuries has been the growth in global trade. Before 1800, global trade probably never exceeded 10% of the world s GDP. Spurred by the industrial revolution and the expansion of the British Empire, trade took off in the 19 th century and by the beginning of the 20 th century it had more than tripled as a share of world GDP. This first great wave of globalisation came to an abrupt end with the outbreak of World War I (WWI). Economic and political instability in Europe after WWI led to a wave of populist movements across Europe. The Communist Revolution in Russia in 1917 was followed by Mussolini coming to power in Italy in 1922, Hitler in Germany in 1933 and Franco in Spain in Then, as now, populism spanned ideologies from left to right. At its core, though, populism posits a struggle between the pure people (represented by a charismatic leader) and the corrupt elite... A conflict between us and them with them including anyone from the elite to foreigners and minorities. Populist policies are typically nationalist, anti-immigrant and favour protectionism. The economic consequences of populism have invariably been very negative and include, in extremes, hyperinflation and falling real GDP. TRADE AS A SHARE OF WORLD GDP ( ) 70% 60% 50% 40% 30% 20% 10% 0% Sources: OurWorldInData.org and the World Bank and FactSet. Estimates for 1500 and 1820 are the midpoint of the upper and lower bounds provided by Estevadeordal, Frantz and Taylor (2003); estimates for from Klasing and Milionis (2014); estimates for from the Penn World Tables Version 8.1 and estimates for from the World Bank. GLOBALISATION S SECOND WAVE After WWII global trade once again surged, as Western economies deliberately fostered global cooperation and trade. This was kick-started by the Bretton Woods agreement in 1944, which was the first global monetary policy accord and led to the formation of the International Monetary. The General Agreement on Trade Tariffs was signed in 1947 and set out to reduce tariffs and promote international trade. Subsequent global trade agreements resulted in the formation of the World Trade Organisation (WTO) in China joined the WTO in 2001 and, according to the WTO, the organisation s members now account for 98% of world trade. The WTO has presided over a sharp fall in global tariffs. According to the World Bank, tariffs in the Organisation for Economic Co-operation and Development (OECD) member countries have fallen by 61% since 1988, to an average level of 1.7%. Average tariffs in China have fallen by 89% since 1992, to an average level of 3.5%. In Europe, the 1951 European Charter aimed to make war unthinkable and materially impossible". It led to the formation of the European Coal and Steel Community in 1952 and the European Economic Community in These were replaced in 1992 by the European Union, which has expanded since then to include much of Eastern and parts of Central Europe. This deliberate policy of promoting global cooperation and trade has paid significant dividends, with global trade rising from just 10% of world GDP in 1945 to more than 60% by 2008.

2 THE PEAK IN GLOBALISATION? 2008 appears, for now, to be the high-water mark in global trade. Since then, global trade has fallen back to just 56% of world GDP. In part, of course, this reflects slower growth in trade since 2008, but it also echoes the experience between the two World Wars when populism eroded support for international trade. In Europe, for example, the Tony Blair Institute for Social Change estimates that populist parties electoral support has gone from 9% in 2000 to 24% in The Timbro Authoritarian Populism Index, which tracks populist support in Europe from 1980 to 2017, shows that having been static at about 11%, support for populist parties increased to 19%. In part, this reflects a widespread dissatisfaction with the European Union and a concern about immigration. The most visceral expression of this was the surprise decision by the United Kingdom to leave the European Union (EU). It is clear that as memories of the WWII fades, the EU is increasingly under threat from within. AVERAGE SUPPORT FOR POPULIST PARTIES IN EUROPE PERCENT OF VOTES 25% 20% 15% 10% 5% Source: Timbro Authoritarian Populism Index, Andreas Johansson Heinö, Timbro, US A DANGEROUS SHIFT TO POPULISM Outside of the EU, emerging markets are no stranger to populism. Russia and Turkey are two examples of major countries with authoritarian, populist leaders. Perhaps the most significant development, though, has been the election of Donald Trump in the United States. Aiming to put America First, Trump has blamed immigrants, the Chinese, the political elite in Washington and the media for all that ails America. Since being elected, Trump has clamped down on immigration, increased tariff protection, frequently criticised the judiciary and media and undermined international organisations like NATO. Trump s actions fly in the face of much of what has been done since WWII to build a peaceful cooperative global political economy. How far he goes remains to be seen. It is likely that as the economic consequences of his actions become apparent there will be more push back. The immediate consequences of the tariff increases already implemented by the US (see table) are still expected by economists to be relatively modest. However, should Trump continue to up the ante, the consequences will be slower growth and higher inflation unwelcome developments for both Trump and the markets. While most economists expect the US to back off from a full-scale trade war, history cautions that politicians, especially populist ones, don't always follow the advice of economists. A continued drift towards populism, with all it entails, is a key risk for the global political economy. US TARIFFS IMPLEMENTED TARIFF Solar panels and washing machines Steel & aluminium tariffs Tariffs on US$50bn worth of Chinese products Two sets of US$200bn in Chinese tariffs Finished automobile import tariffs LIKELIHOOD OF IMPLEMENTATION Implemented Implemented Mostly implemented 1st set of tariffs on US$200bn high probability (in process) of being implemented; 2nd US$200bn medium probability of being implemented Medium to high probability of being implemented PERCENT & SCOPE 20% tariff on washing machines; 30% tariff on solar panels 25% tariff 25% tariff; US$34bn implemented on 6 July; US$16bn forthcoming 10% tariff, up to US$400bn 25% tariff on US$176bn worth of imports, some exemptions likely SOUTH AFRICA SWIMMING AGAINST THE TIDE Source: UBS As is often the case, South Africa appears to be swimming against the tide. But this time at least we are swimming the right way. While other parts of the world are drifting towards populism, President Ramaphosa is doing his best to turn South Africa back from the populist path followed by Zuma. The euphoria that greeted Ramaphosa s election as president has faded, but it is clear that he is committed to rebuilding South Africa s institutions, fighting corruption and re-engaging in genuine dialogue with Government s social partners. This stands in marked contrast to the populism of the Zuma era, which was characterised by corruption, spiralling government debt and a flagrant disregard for independent institutions, all justified in the name of the people and radical economic transformation. South Africa clearly has a long way to go, but we are headed in the right direction. Despite a very uncertain outlook, this means investors should be careful of being too pessimistic about South Africa. Consequently, in the portfolios that we manage we have exposure to selected South African assets, such as bonds, property and local equities that we think offer reasonable value and should benefit from a gradually improving South African outlook.

3 MARKET COMMENTARY AS AT THE END OF JUNE 2018 The performance of investment markets during the second quarter of 2018 was all about the US Federal Reserve (the Fed), the dollar and Trump s trade wars. Better growth in the US than in other parts of the world pointed to the Fed being likely to continue their hiking path perhaps faster than previously expected. The increasing cost of capital, dollar strength and Trump s trade tariff moves weighed on emerging market currencies and markets in particular. Precious metals were weaker, but geopolitical tensions saw the oil price firm considerably. The negative impact of rand weakness, with rate hikes now more likely than further cuts, as well as disappointing local growth, saw South African investment markets come under pressure during the quarter. Bonds and quoted property were weaker, with yields kicking up, and locally orientated shares such as financials and retailers declined. It was essentially the strong performance of rand hedges Naspers, Sasol and the diversified miners which brought the FTSE/ JSE Capped SWIX Index return back up to being close to flat. OLD MUTUAL MAXIMUM RETURN FUND OF FUNDS (Peter Brooke and Arthur Karas) (Classification category: Worldwide Multi-Asset Flexible) It has been a tough quarter for South Africa as the rand has sold off in the face of an emerging market meltdown, as the US dollar has powered stronger. Bad news for the rand is typically good news for the Maximum Return of s, as it has a large proportion of its assets invested offshore, which benefit from the weaker rand. However, we are becoming a little more cautious on offshore equity, which has been our favourite asset class. This is because of the steady increase in the US interest rates, which will start to provide a headwind in As a result, we are investing more of the fund s assets locally. We see better value in local bonds, local financials and in some of the smaller companies in South Africa which have very depressed earnings. While the outlook for the local economy appears bleak at the moment, we believe that it will start to improve and these companies will start to recover. We now have roughly half our assets invested offshore and half in South Africa. This is much more than one would find in a typical South African unit trust, but it does mean that we will benefit less and less from a weaker rand. However, the cheaper valuations locally will provide a higher probability of delivering high real returns in the long run. Returns over the last year have been 8.5% and over the last five years they have been 10.6% per annum. OLD MUTUAL FLEXIBLE FUND (Peter Brooke and Arthur Karas) (Classification category: South African Multi-Asset Flexible) The Flexible lagged its peer group slightly in June, while performing very much in line with peers in the second quarter of Over the last 12 months, the fund s performance has been in the upper quartile. With the macro environment weighing heavily on emerging markets, it was the global investments, both dual-listed shares and the offshore holdings, that had to carry the portfolio. The uninspiring South African economy has left many of the fund s domestic stock picks directionless and most of the month s positive equity excitement has come from rand hedge holdings, including Sasol, Sappi and Naspers. The fund s South African equity holdings are sufficiently cheap that we are unconcerned about short-term underperformance. Diversification across global equity and local interestbearing investments is providing a hedge against domestic equity volatility. One of the fund s largest equity holdings unbundled at the end of the month when plc split into Quilter Plc and Ltd. In due course, Ltd will also distribute a portion of its holdings in Nedbank. We expect the share prices to take some time to settle down while shareholders across various markets re-position their portfolios. Passive holders are expected to be forced sellers as a number of index changes take effect. We are planning to be patient and not to read too much into the initial market movements. The Flexible is well positioned to deliver on its performance objectives over its investment horizon. OLD MUTUAL BALANCED FUND (Graham Tucker and Warren van der Westhuizen) (Classification category: South African Multi-Asset High Equity) The pressure on emerging markets during the second quarter of 2018 resulted in a challenging period for the fund given the positive leaning towards growth assets and a preference for local investments. Despite this, the fund delivered positive returns for the quarter and remains competitive over periods of one year and longer. Disappointingly, absolute returns remain subdued as a consequence of the weaker returns observed in growth assets. Despite the negative impact on emerging markets created by the strength in the US dollar and Trump s trade agenda, we remain firm in our view that South Africa is on the long road to recovery. Government is taking steps in the right direction, such as, among others, starting to repair the state-owned enterprises, tackling deep-rooted corruption and making progress on labour reform through the passing of the strike ballot legislation. We would expect these actions, and others still in the pipeline, to improve the future growth path for the country. Accordingly, we have again increased exposure to local bonds into weakness. Continued solid global growth bodes well for global equities, while higher interest rates and inflation and reduced demand as quantitative easing measures are removed should continue to put upward pressure on global bond yields in the medium term. As such, global equities are preferred to global bonds. Within global equities, Europe is our favoured region given the stage of the investment cycle and relative valuations. The local equity portion of the fund remains well balanced; however, with a leaning towards local companies that we expect to benefit from the gradual local recovery. These companies tend to be smaller and less liquid. Given the manageable size of the fund, we have been able to build significant positions in these counters in recent months. The volatility we ve seen of late could stay with us in the coming months. As mentioned in past commentaries, we are looking to embrace this volatility, to see it as an opportunity rather than to flee from it.

4 MARKET COMMENTARY CONTINUED OLD MUTUAL MODERATE BALANCED FUND (John Orford and Alida Jordaan) (Classification category: South African Multi-Asset Medium Equity) In spite of the tough market conditions, the fund delivered positive returns over the past quarter. In the very short term being overweight to growth assets relative to its benchmark has detracted from performance, but over the last year the fund s return remains ahead of its target of beating inflation by 3% to 4%. The neutral local equity position showed returns in line with the Capped SWIX benchmark. Overweight positions in selected rand hedge counters like Sasol, Sappi, Mondi, Glencore and Anglos contributed to performance, while overweight positions in locally focused companies, e.g. The Foschini Group and MPact, detracted from performance. The fund is positioned to benefit from a recovery in growth assets, in particular local property, which is likely should the rand show some resilience. The level of the rand would partly depend on the strength of the US dollar, which will be determined to a large extent by the growth in the rest of the world. The direction of the US dollar has implications for the local currency and the capital and equity markets. OLD MUTUAL STABLE GROWTH FUND (John Orford and Alida Jordaan) (Classification category: South African Multi-Asset Low Equity) In spite of the tough market conditions, the Stable Growth delivered positive returns over the past quarter. In the very short term, being overweight to growth assets relative to its benchmark has detracted from performance, but over the last year the fund s return remains ahead of its target of beating inflation by 2% to 3%. The neutral local equity position showed returns in line with the Capped SWIX benchmark. Overweight positions in selected rand hedge counters like Sasol, Sappi, Mondi, Glencore and Anglos contributed to performance, while overweight positions in locally focused companies, e.g. The Foschini Group and MPact, detracted from performance. OLD MUTUAL REAL INCOME FUND (John Orford and Zain Wilson) (Classification category: South African Multi-Asset Low Equity) The fund aims to deliver an income that grows over time while protecting capital. performance has been poor year to date, underperforming both cash and bonds, which have returned 3.6% and 4% year to date respectively. While the difficult domestic environment has weighed on returns over the short term, the fund has continued to exceed its target of CPI + 1-2% net of fees since exception. With little difference between domestic bond and cash returns over the year, the core of the fund, invested in low duration domestic credit, remains set to deliver an above cash yield of 8.4%. The weighted yield on the fund of 8.3% including growth assets, remains well above cash yields of around 6.5%. While credit has continued to do well, the lack of evidence of domestic recovery following South Africa s Q1 GDP growth contraction, has exacerbated concerns around the economy. Subsequently, any assets exposed to domestic growth have been under pressure. In particular, the fund holds a meaningful position in South African property, which has been the primary contributor to the fund's recent underperformance. These assets, which trade off of domestic bond yields, have been doubly hurt by weakness in emerging market bonds in general, and South Africa in particular, as global concerns have risen around a stronger US dollar. Many of these property shares are now trading at yields in excess of 9%, the highest we have seen since the Global Financial Crisis. While appropriate risk management limits how much we hold in the fund, outside of a domestic growth shock, this is not the time to sell assets we believe hold value. Sources: returns and rankings are sourced from Morningstar Direct. All other data is sourced from Deutsche Bank Equity Research and FactSet. The fund is positioned to benefit from a recovery in growth assets, in particular local property, which is likely should the rand show some resilience. The level of the rand would partly depend on the strength of the US dollar, which will be determined to a large extent by the growth in the rest of the world. The direction of the US dollar has implications for the local currency and the capital and equity markets.

5 THREE-YEAR PERFORMANCE: (TO 30 JUNE 2018) ASSET ANALYSIS: (AS AT 30 JUNE 2018) 7.0% 6.0% 6.3% p.a. CPI 5.2% p.a. 5.4% p.a. 5.0% p.a. 5.2% p.a. 6.0% p.a. 6.4% p.a. 6.6% p.a. 6.4% p.a. 6.6% p.a. 100% 75% 5.0% 4.0% 50% 3.0% 2.0% 25% 1.0% 0.0% Maximum Return of s Flexible Flexible Life Balanced Balanced Life Moderate Balanced Stable Growth Stable Growth Life Real Income Real Income Life Sources: Investment Group & Morningstar 0% Maximum Return of s Flexible Flexible Life Balanced Balanced Life Moderate Balanced Stable Growth Stable Growth Life SA Equities Property Preference Shares Commodities Nominal Bonds Convertible Bonds Inflation-linked Bonds Cash International Africa Real Income Real Income Life Sources: Investment Group & Morningstar 3 years 5 years Performance 30 June year (p.a.) (p.a.) Highest 2 Average 2 Lowest 2 Description TER 1 TC 1 Maximum Return of s 8.5% 6.3% 23.6% 9.9% -3.8% 1.86% 0.11% Benchmark*** 11.4% 7.8% UT Peer Average 8.6% 6.3% Worldwide - Multi-Asset - Flexible Flexible 9.9% 5.2% 54.0% 14.3% -26.9% 1.64% 0.18% Flexible Life 10.1% 5.4% 52.9% Target: CPI + 5% to 7% p.a. 9.4% 10.3% 23.1% CPI + 5% to 7% p.a. over rolling 3 years UT Peer Average 5.9% 3.2% 47.1% South African - Multi-Asset - Flexible Balanced 8.6% 5.0% 45.5% 13.4% -23.2% 1.64% 0.12% Balanced Life 8.8% 5.2% 46.5% Target: CPI + 4% to 5% p.a. 8.4% 9.3% 22.1% CPI + 4% to 5% p.a. over rolling 3 years UT Peer Average 7.2% 4.6% 44.9% South African - Multi-Asset - High Equity Moderate Balanced A 9.3% 6.0% 12.7% 5.9% 0.7% CPI + 3% to 4% p.a. over rolling 3 years 1.82% 0.22% Target: CPI + 3% to 4% p.a. 7.4% 8.3% UT Peer Average 6.9% 4.8% South African - Multi-Asset - Medium Equity Stable Growth 8.4% 6.4% 18.6% 8.5% -5.3% 1.61% 0.06% Stable Growth Life 8.6% 6.6% 37.5% Target: CPI + 2% to 3% p.a. 6.4% 7.3% 20.1% CPI + 2% to 3% p.a. over rolling 3 years UT Peer Average 6.9% 5.7% 32.4% South African - Multi-Asset - Low Equity Real Income 6.2% 6.4% 15.4% 8.8% -0.7% 1.41% 0.07% Real Income Life 6.4% 6.6% Target: CPI + 1% to 2% p.a. 5.4% 6.3% 19.1% CPI + 1% to 2% p.a. over rolling 3 years UT Peer Average 6.9% 5.7% 32.4% South African - Multi-Asset - Low Equity CPI 4.4% 5.3% 18.1% 1 Total Expense Ratio is a historic measure and includes the annual service fee. A higher TER does not necessarily imply a poor return, nor does a low TER imply a good return. The current TER may not necessarily be an accurate indication of future TERs. Transaction Cost (TC) is a necessary cost in administering the fund and impacts fund returns. It should not be considered in isolation as returns may be impacted by many other factors over time including market returns, the type of fund, the investment decisions of the investment manager and the TER. TERs and TCs as at 30 June Rolling 12-month returns (since inception). 3 Composite benchmark: 60% FTSE/JSE Capped Shareholder Weighted Index, 35% MSCI All Country World Index, 5% STeFI Composite Index. 4 The CPI figures are lagged by one month as the number was calculated before this month s inflation rate was released. Sources: Morningstar and Wealth FOR MORE INFORMATION, VISIT: Investment Group (Pty) Ltd PO Box 878, Cape Town 8000 Tel: Fax: Statutory information applicable to collective investment portfolios listed in table above: You should ideally see the funds as medium- to long-term investments. The fluctuations of particular investment strategies affect how a fund performs. Your fund value may go up or down. Therefore, we cannot guarantee the investment capital or return of your investment. How a fund has performed in the past does not necessarily indicate how it will perform in the future. The fund fees and costs that we charge for managing your investment are disclosed in the relevant fund s minimum disclosure document or table of fees and charges, both available on Unit Trusts' public website or from its contact centre. Additional information of the proposed investment, including brochures, application forms and annual or quarterly reports, can be obtained, free of charge, from Unit Trust Managers (RF) (Pty) Ltd, from our public website at or our contact centre on The cut-off time for client instructions (e.g. buying and selling unit trusts) is at 15:00 each working day. This is also the time we value our funds to determine the daily ruling price. Daily prices for Unit Trust Managers (RF) (Pty) Ltd funds are available on the public website and in the media. Unit trusts are traded at ruling prices, may borrow to fund client disinvestments and may engage in scrip lending. The daily price is based on the current market value of the fund s assets plus income minus expenses (NAV of the portfolio) divided by the number of units in issue. Income funds derive their income primarily from interest-bearing instruments as defined. The yield is a current yield and is calculated daily. A fund of funds is a portfolio that invests in other funds that levy their own charges, which could result in a higher fee structure for the fund of funds. Some funds hold assets in foreign countries and therefore may have risks regarding liquidity, the repatriation of funds, political and macroeconomic situations, foreign exchange, tax, settlement, and the availability of information. The Net Asset Value to Net Asset Value figures are used for the performance calculations. The performance quoted is for a lump sum investment. The performance calculation includes income distributions prior to the deduction of taxes and distributions are reinvested on the ex-dividend date. Performances may differ as a result of actual initial fees, the actual investment date, the date of reinvestment and dividend withholding tax. Annualised returns are the weighted average compound growth rates over the performance period measured. Performances are in ZAR and as at 30 June Unit Trust Managers (RF) (Pty) Ltd is a registered manager in terms of the Collective Investment Schemes Control Act 45 of is a member of the Association for Savings and Investment South Africa (ASISA). Unit Trusts has the right to close the portfolio to new investors in order to manage it more efficiently in accordance with its mandate. MacroSolutions is a boutique within Investment Group (Pty) Ltd (Reg No 1993/003023/07), a licensed financial services provider, FSP 604, approved by the Financial Sector Conduct Authority ( to provide intermediary services and advice in terms of the Financial Advisory and Intermediary Services Act 37 of Investment Group (Pty) Ltd is wholly owned by Investment Group Holdings (Pty) Ltd and is a member of the Investment Group. The investment portfolios may be market-linked or policy based. Investors rights and obligations are set out in the relevant contracts. Unlisted investments have short-term to long-term liquidity risks and there are no guarantees on the investment capital nor on performance. It should be noted that investments within the fund may not be readily marketable. It may therefore be difficult for an investor to withdraw from the fund or to obtain reliable information about its value and the extent of the risks to which it is exposed. The value of the investment may fluctuate as the value of the underlying investments change. In respect of pooled, life wrapped products, the underlying assets are owned by Life Assurance Company (South Africa) Limited, who may elect to exercise any votes on these underlying assets independently of the Investment Group. In respect of these products, no fees or charges will be deducted if the policy is terminated within the first 30 days. Returns on these products depend on the performance of the underlying assets. July 2018