Investing and the Elephant in the Low-Growth Room
The global economy is stuck in low gear, signaling more years of subpar yields and risk-on/risk-off market skirmishes. So we offer some ideas on how equity investors can get their portfolios battle ready.
The potential GDP growth of the developed world has halved over the past 20 years, from just below 2% per year to less than 1% today. The drop across emerging markets has been similarly dramatic.*
We see several megatrends at work: aging world populations, rising income inequality and deglobalization are structurally depressing productivity and, in turn, economic growth. By deglobalization, we mean the unraveling of the over 20-year advance of global trade and cross-border capital investment.
GLOBALIZATION IN RETREAT
One prominent driver of deglobalization could have lasting effects: the growing political backlash against globalization in advanced nations (witness Brexit and the rising protectionism in the US and eurozone). What’s behind this pendulum swing? For context, let’s look at the “elephant chart,” so called because of its distinct shape (Display). Based on research from economist Branko Milanovic, the chart reveals the stark divide between the winners and losers of globalization.
The chart ranks the global population from the lowest to the highest percentiles of household income, and measures each percentile’s real income growth between 1988 and 2008. The biggest beneficiaries by far have been emerging-market middle classes (Point A) and the richest 1% in developed markets (Point C), half of which are Americans. Those on the losing end (Point B) are the working and middle classes of the US, Japan and Western Europe, where incomes have stagnated.
Globalization is too well entrenched to be stopped completely. And we’re seeing a steady increase in regional trade pacts. Even so, the slowdown in global trade and the dearth of cross-border investment are feeding back on each other, and could continue to be significant drags on the global economy.
Given the higher probability of a prolonged period of low global growth, investors will need strategies that can persevere in that scenario. We offer three criteria:
1. IDENTIFY NEW POCKETS OF GROWTH
Low growth doesn’t mean no growth anywhere. New markets will emerge, and the companies at the forefront of these markets will be more prized in a growth-scarce world. Examples of potential growth sources include technological innovations across the broad e-commerce domain and shifts in consumer tastes and preferences, such as the growing demand for healthy foods and lifestyles.
Two other examples: the shrinking working-age population is likely to boost demand for productivity-improvement tools and services via software-assisted solutions, while increased geopolitical instability could drive higher defense spending.
2. FOCUS ON PROFITABILITY WITH STAYING POWER
In a low-growth world, demand for products and services can easily evaporate. So look for companies with durable competitive advantages that enable them to maintain high and predictable profitability for longer than the market gives them credit for. The sources of this sustainability can vary—from a well-defended network effect to a hard-to-replace service or beloved brand to a low-cost production process.
3. STICK WITH SHREWD CAPITAL MANAGERS
In times of stronger economic activity, overinvestments in capacity are eventually absorbed as demand grows, essentially bailing out the managers who made those bad decisions. In a low-growth world, there is far less wiggle room. Today, investment-worthy businesses achieve scale cheaply and allocate capital judiciously. A strong balance sheet provides a solid line of defense in times of greater uncertainty.
Investors face a tough slog ahead. Corporate managements and investors need to understand and adapt to the broader context. In today’s market, we believe that a selective, active approach, focused on sustainable profitability at an attractive price, is the best way forward. For the vigilant and nimble investor, there will be opportunities for the taking, even in a sustained low-growth world.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.
*Organisation for Economic Co-operation and Development, OECD Economic Outlook, 2016.