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If You’re Thinking About Global Diversification, You Should Read This


  • The developed world is depending, and will continue to depend, more and more on the developing world.
  • The focus of productivity and GDP growth is in Asia.
  • The U.S. is the only country with trade deficits since 1976.

Introduction

Nobody knows where the market will go in the next week, month, or year, but what can give investors an edge is to look at macro trends that are bound to influence economies and returns on investments.

In this article we are going to analyze productivity and trade balances among the most important global economic powers, and try to derive a long term trend from it in order to improve the international exposure in our portfolios.

Productivity

Productivity is essential for economic development in the long term, and in the short term is only beaten by credit. But as credit has its cycles in the long term, productivity is what determines if a country is a success or not because credit can only be used up to a point. Productivity is the mechanism through which societies progress.

The issue with productivity is that it is stuck globally. This is because productivity is falling in the U.S. and Japan, slowing down in China, and countries like India still don’t manage to compensate for the declines of these superpowers. However, the trend is clear.

figure 1 productivity
Figure 1: Labor productivity growth rates. Source: Conference Board.

The trend shows how the largest global productivity and GDP growth comes from Asia with some bright spots in Africa. As Africa is still undiscovered as an investment opportunity and complicated to invest in, it is good to focus on Asia for international long term diversification.

Higher productivity means that people are achieving more with their own means, education and capital, which improves economics and living standards. This further improves education and healthcare which creates an upward spiral. As Asian countries have a low baseline, there is plenty of room and time for them to develop and grow.

Jim Rogers, co-founder of the famous Quantum Fund with George Soros, is heavily invested in Vietnam. Of course, such an investment is difficult to make as it has many capital constraints at the moment, but it shows you where smart money is going.

A country that is easier to invest in is India, which had a GDP growth rate of 7.3% and productivity growth of 5.2% in 2015. The fact that productivity growth in the U.S. was 0.7% in 2015 and GDP growth was at 2.4% means that GDP growth isn’t exclusively influenced by long term, healthy productivity increases, as is the case in India, but is also greatly influenced by debt. We all know that debt works in cycles, so sooner or later we will see some deleveraging take place that will send the U.S. into a recession, hopefully later than sooner so that we can still enjoy this bull market for a while longer. The situation is the same in Europe; productivity grew at 0.9% while GDP grew at 2.0% in 2015.

Balance of Trade

Among other factors like productivity and credit cycles, the balance of trade (BOT) is a very important factor for assessing the health of an economy. The BOT is often shunned by economist as one country has had a BOT deficit for 41 years and things seem to still go pretty well there. We are of course talking about the U.S. which saw its last trade surplus in 1976.

figure 2 U.s. balance of trade
Figure 2: U.S. BOT. Source: Trading Economics.

This means one thing: the U.S. is spending more than it is producing which is not news, but is good to have in mind when deciding where to go with your global investments.

Other countries—like the U.K., Canada and Brazil—also have BOT deficits, but they have evened out in the long term with past surpluses, with things being a little bit worse for the U.K.

figure 3 canada
Figure 3: Canada BOT. Source: Trading Economics.

Europe, China and Japan have a surplus in their trade balances.

figure 4 EU balance of trade
Figure 4: Europe BOT. Source: Trading Economics.

BOTs show only one side of the equation where usually net investments cover for the trade deficit. But the current account for the U.S. is also negative.

figure 5 current account
Figure 5: U.S. current account. Source: Trading Economics.

Conclusion

The world will be a very different place in 20 years as global trade, productivity and economic growth shifts from the western world toward Asia. With countries like India and Indonesia reminding us of what China was 20 years ago, we should not be surprised if such a scenario replicates itself in those and other emerging countries.

This doesn’t mean that we should be completely invested in emerging markets, but if we have to choose between a company that has sales only in the U.S. and a company that is selling globally for the same valuation, we ought to go for the global one as global macroeconomic long term trends are clear and unavoidable.

The good news is that emerging markets growth is what will push the currently stuck developed economies forward as increases in global demand will be good for everyone.

 

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