The years since the global financial crisis did not see the return of strong global trade and economic growth rates of the early noughties, but with Donald Trump’s election as US president, protectionist rhetoric evolved into a full trade war with China. Although equity markets were optimistic about the signing of a Phase One deal in January, Covid-19 has given rise to practical and political issues that make the outlook for global trade look questionable. Lockdowns have led to dramatic falls in demand and brought the travel and leisure industry to a stop, clipping the wings of an industry that had been a bright spot for growth. The WTO has warned that it expects a significant rise in costs associated with extra border checks and extra time in transit as a result of travel restrictions that have been put in place.
The scrutiny of supply chains is not limited to company management, with governments considering earmarking some strategically important goods with a requirement that they are sourced locally, or from more than one country. Cross-border mergers and acquisitions are also likely to be more tightly restricted, with regulators potentially blocking deals with foreign suitors.
Surveys reveal that even before Covid-19 many companies were looking at adjusting their businesses to be less reliant on China for sourcing and manufacturing, but not all companies will follow the same path. Near-shoring might be the preferred option for companies where the finished goods rely on the assembly of many components, but the benefits might not be so pronounced for simpler products such as clothing, where the better option might be to diversify production across several countries, to provide some protection against any future problems while maintaining a foothold in China. These changes could take years to bear fruit, with companies running higher production costs in the medium term.
After enjoying fatter profit margins over the last decade, the operating environment for businesses will bring new challenges as Covid-19 looks set to accelerate a number of global trends. Having benefited from lower interest rates and rates of taxation, as well as labour costs claiming a smaller percentage of the pie, corporates may now feel the wind is changing. Higher tax and operating costs look likely, in an environment where growth is likely to be anaemic. With that in mind it will be interesting to see as companies return to profitability whether there is a trend to favour dividends over share buybacks.
More broadly, it has prompted discussion in our investment team as we weigh up the challenges facing equities against some of the structural changes to markets that could underpin equity investment. As more people are living longer in retirement, investors may need to hold equities for longer and the relative attractiveness of equities and bonds may lend support to equity markets. These longer term themes continue to influence our decision-making as we resist the temptation to become fixed on the short term.