What Are The Equity And Sector Implications Of De-Globalization?
* December 20, 2016
The most profound and simultaneously provocative investment implication from the end of globalization is that real earnings have plateaued and will likely come under pressure. Reconstructed S&P 500 EPS data date back to the mid-1920s. Historically, corporate profits and globalization have been positively correlated. As globalization intensifies, global trade links deepen and “borders fall,” boosting companies’ international revenue exposure. The opposite occurs under de-globalization. Typically, higher top-line growth from foreign markets has also been associated with increasing overall sales and profitability. However, the tide has already started receding. If President-elect Trump’s policies sabotage global trade, then internationally sourced turnover has more room to fall, likely weighing on overall sales and EPS.
On the inflation front, not only is de-globalization inherently inflationary, but most of Trump’s policies also lead to inflation. On a shorter-term basis energy prices will also add fuel to the looming inflationary backdrop. If crude oil prices move sideways from current levels, oil inflation will be up 100% in February 2017, and given the historical correlation with headline and core CPI, some transitory inflation effects will flow through the data.
The inflation-related equity-market investment implications are threefold.
First, the broad equity market’s P/E multiple moves inversely with inflation. The chart shows that since 1926 a rising inflation impulse caps multiple-expansion phases, and a waning impulse leads to an equity market rerating. The link is via the ebbs and flows of the fed funds rate or the discount rate. As the economy gains steam and inflation propagates, the Fed acts belatedly and tightens monetary policy. A higher/rising fed funds rate leads to a multiple contraction phase. Since 1979 (when forward EPS data commence), every time the Fed has embarked on a tightening cycle the forward P/E multiple has been squeezed.
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