Actively Speaking Podcast
Steve Bleiberg, portfolio manager and thought leader at Epoch Investment Partners, Inc. (TD Epoch) takes on current topics and issues facing today's investor.
Actively Speaking Podcast
Reinventing Globalization
For three decades, "globalization" was the dominant economic paradigm. But in the wake of pandemic, war, and a new geopolitical reality, the tide of globalization is reversing. In this episode, Global Investment Strategist Kevin Hebner explains what that will mean in the near term for some key industries like energy and technology, and what other impacts we might see in the longer term. We also discuss the challenges for Chinese equities and U.S.-based multinational corporations, which have been the two biggest beneficiaries of globalization. (December 1, 2022)
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Hello, and welcome to Actively Speaking. I'm your host, Steve Bleiberg. Join us each episode as we discuss current issues concerning capital markets and portfolio management from the perspective of an active manager. Welcome back to another episode of Actively Speaking. Uh , and my guest today is Kevin Hevner, our global strategist here at Epic. Hi Kevin.
Speaker 2:Hey Steve.
Speaker 1:Uh, and Kevin has a, a new paper that he's gonna talk about with us called Reinventing Globalization. Why don't you kick us off, Kevin, and tell us , uh, at a high level what's , uh, what the paper is about?
Speaker 2:So the paper is about how we're rethinking globalization in light of a number of things. Clearly, COVID has made us realize that we're vulnerable, and we learned that through productive production equipment, through active pharmaceutical agreements, ingredients, and things like that. Also, I think with the Russian invasion of the Ukraine, especially Europe's realize there's vulnerabilities with , um, with trade for essential energy and things. And then I , I think more broadly with semiconductors and, and other items that are part of the global supply chains as tensions between the United States and China have ratcheted up, we're re realizing that there are a lot of vulnerabilities , uh, inherent in global supply chains. And, and also we're realizing to some extent that we've been providing our number one global strategic rival with a lot of goods that are, you know, certainly they have civilian purposes, but they also have military potential as well.
Speaker 1:Okay. So, and in this paper, there's basically two parts to this paper. The first part you talk kind of , uh, a history of globalization, how it got started, say in the eighties, nineties, when it really took off, and then the , the factors that are causing it to reverse today as , as including the ones you just mentioned. Yeah. And the second part is, is really interesting. I think it's perhaps things that people don't think as much about. I mean, some of the stuff is obvious, like, okay, so we're moving manufacturing either, you know, reshoring it to other countries or onshoring it back to the us But there are implications that you talk about in the paper for what does this mean for things like, you know, labor share of , of income in , in countries like us , or what does it mean for the cost of capital? Talk about some of those , uh, things that you think are perhaps less appreciated.
Speaker 2:And overall, I think very little of this is fully appreciated yet, and I , I don't think people have come to terms with how after this period of hyperglobalization we've had for 40 years, how this is reversing and, and how it's going to affect , uh, I think at a fundamental level, a lot of things, you know, one part of it is , uh, CapEx boom, a domestic CapEx boom, which certainly we will have, and we're starting to see already in semiconductors. Luckily we've had in fossil fuel energy already, but also in green energy , uh, in a host of areas. And that's gonna be a challenge for the US economy, which has been so focused on tech and building up the world of bits when we actually have to build up the role of atoms. It's not something we're really prepared for. We don't have the right skillset from a labor supply perspective. We don't have the right regulatory environment, and that's gonna be huge at the local state and federal level. There's all sorts of regulatory hurdles that to make building anything incredibly time consuming, but also very expensive in terms of the labor share with the combination of deglobalization as well as the demographics and aging. And also decarbonization, we'll certainly seeing increased labor demand. So the labor share is going to go up, as we've certainly seen over the last year with very strong wage growth. I think we will be having higher wage growth over the next decade relative to what we experienced last decade. And , uh, with that, the labor share of global profits, labor share of GDP both increasing
Speaker 1:And it has implications for inflation too, presumably.
Speaker 2:Yeah . So for example, the last decade, maybe a little bit before that, the chief issue for the Fed as well as the EECB Bank of Japan host of is that inflation's been too low going forward, I think it's gonna be very different. I think with higher wage growth and a lot of pressure points through CapEx and the labor share, that is gonna be much more difficult to keep inflation down towards a 2% target rather than trying to be pushing it up. So monetary policy is gonna be very different. The four decade downtrend we've seen in bond yields, mortgage rates, cost of capital for corporations, that's all going to be reversed and look quite different. So in some sense, it's marking , uh, a regime change, which is certainly important for the economy. It's also extremely important for I think, analyst, PMs and , and financial markets. Well,
Speaker 1:Sure. I mean , um, uh, you know, I , I've written that one of the papers on our website is PE ratio, a user's manual, where we talk about the role that return, the spread you earn of your return on capital versus your cost of capital. How that ultimately really is what drives the , the level of PE ratios for a business. And if, you know, presumably if cost of capital goes up, unless companies can also ratchet up the ROIC too to , to keep maintaining the spread. That does imply this is important for investors, implies like lower PE ratios.
Speaker 2:Yeah, so certainly multiple compression relative to last decade, I think that's reasonable to expect. Um , bill Priest likes to talk about a south side report that came out about five years ago that had the line when money is free, dreams are reality, it's pretty crazy. But that type of environment, when money is free, you don't necessarily have to have sustainable free cash flow in the next couple years. You can have stories about how at some point in the future we're gonna make money. And I think, I think this sort of environment is gonna be quite challenging for venture capital and speculative tech that don't really see , um, the possibility of having free cash flow on a sustainable basis for, for quite a few years to come. So I do think that looking at returns on invested capital relative to wac , I I think that will become a much more important focus for analyst investors going forward.
Speaker 1:So you , you had a line in the paper that I can't remember it exactly, but it was , it was , um, I found it kind of amusing saying something about how globalization was always beloved of economists <laugh> , and , and they will kind of, they, they, they will , um, you know, miss the , uh, the deglobalization to economists is bad because like, oh, it's less efficient. And, and , and my feeling was , um, that's true, but it's like, it's not just economists who benefited from globalization. I mean, it was consumers and , and not just in the form of well, we had lower inflation because, you know, we , we basically, you know, replaced higher costs , uh, labor with lower cost labor, and so prices of things went down. But you know, what I like to focus on is, but what did that, what those lower prices enable consumers to do with the other money that they previously would have spent on certain goods, now they had more money left over , which meant they could spend it on other things. And that creates new industries, you know, dynamism, you know, it's all the whole , uh, you know, what's the trumpeter phrase? A creative destruction. I i are you worried that we're gonna , uh, if , if we do kind of drive the price of certain things back up because well now we're gonna be substituting higher cost labor for lower cost labor. It, it takes away money that people in the past that globalization benefited consumers, not just, my point is not just through directly through lower prices, but indirectly because the fact that they had additional income to spend on other things created new industries, new employment jobs, you know, for , and are we gonna lose some of that dynamism?
Speaker 2:Yeah, so in , in the paper we, we mentioned that the, the two biggest beneficiaries of globalization were first of all China. And as globalization unwinds, China's likely to keep underperforming relative to other equity markets like , um, the United States A second is multinational companies benefit a lot, and we've seen that in margins and valuations over the last 30 years. And certainly some of that will rewind . We see their margins challenged in , in free cash flow generation challenge. The third aspect that, that you've raised, we actually don't talk about in the paper. So the notion that there has been consumer surplus from globalization, and certainly this is something beloved of , uh, economists certainly sheer , but going , uh, much, much , uh, earlier than Shater as well. And so yes, we're gonna see prices for a number of goods rise. 1 1, 1 example that I've been thinking about is as we're starting to, to reshore semiconductor fabrication, it's estimated that's gonna cost 30% to 50% more to do that , uh, domestically rather than do that in Taiwan or South Korea. So semiconductors aren't everything. So for example, your iPhone, it has a very advanced semiconductor, the price of that integrated circuit is going to go up. And so the price of your iPhone and other types of smartphones is gonna go up, is some amount , but so will the prices that are paid for cars, which have hundreds of semiconductors in them and so on. And so certainly some of the consumer surplus from that Willy road , and that will, that does destroy value. And ultimately, and I think this is also something that that Bill Priest has emphasized is globalization. It does create a lot of efficiency. It has created a lot of value for multinational corporates, for China and also for consumers. And we are unwinding this and we are in that process in some sense destroying a lot of value. Or maybe it was just that there was this, you know, relatively short ephemeral period in which we created a lot of the value, but that just wasn't sustainable. It was built in a particular time period, and there's no real reason to believe that time period could last for more than a couple decades.
Speaker 1:So you alluded to , uh, the desire to build more semiconductors here in the United States. Do we have, you know , uh, the , the labor force , uh, it seems, I , and there was a quote, I can't remember whether it was in this piece or another piece you circulated about. It's in , you know, it's not just one type of job at these factories that we don't have enough of. It's basically every job. We don't have enough people who are trained to do these things. Yeah. So how do we get around that?
Speaker 2:Yeah, so we don't have enough people. Um, Taiwan also doesn't have enough people. Neither does South Korea, Singapore, or other places that have , uh, semiconductor fabrication. So it's, it's a global issue, but it's particular an issue for the United States where , where we haven't done very much semiconductor fabrication. So we're gonna need certainly PhDs and material sciences and electrical engineering and a , and a host of systems design and so on. And it takes decades to get sort of the thousands and thousands of people we need. But we also need people who are gonna be doing shop floor work and particular skills for that. And it's the, the whole range of skills required for a semiconductor fabrication plan , which is really the, the most sophisticated, well, you could think of , an integrated circuit is the most sophisticated product in the world, and we want to be producing those locally and all the inputs to that, and there's thousands of inputs to building an integrated circuit and there's thousands of skills required. So yeah, it's gonna be a challenge. Um, the good thing is part of the CHIPS Act that was passed in August, there's a lot of money in that for training, but for example, for TSMC and other companies in Taiwan to get to where they're now, this process started in the mid eighties, so it does take decades to build up. Similarly with Korea, it started in the eighties and it started with both Taiwan and South Korea. There's been enormous government subsidies to get the companies to where they are now, and subsidies in lots of ways in terms of tax breaks , uh, uh, land deals, and then helping to build up the skilled workforce. So, and that's, this does not happen quickly.
Speaker 1:Right? And, and it's those subsidies, I believe that if I read you correctly, that's what accounts for that big cost differential of doing it in the US versus those guys . It's not so much oh , that the labor is more expensive here. It's that we don't have the government subsidies that they have.
Speaker 2:Well, part of it is wages. So on average wages in the US are about twice those in South Korea or Taiwan. So part of it is wages , uh, but it isn't really that labor intensive and industry. And then Boston Consulting Group estimates that , um, about half the cost differential is due to government subsidies. So those countries have decided that this is a critical industry and have a lot done a lot to build that up. And it looks like that was probably a sensible type of industrial policy. The the other thing, well, which we mentioned briefly that I, I think it's gonna be enormous challenge, is the, the changes in regulatory frameworks to allow these things to be built and also all the inputs to them to be built. And we know that the United States has , uh, had a very difficult time building anything including infrastructure , uh, that's needed. Anytime something's built, it's it's horrendously expensive income and takes far longer than it should. So I , I think <laugh> , all these elements are gonna be big challenges, but it's surprising how little attention is being paid to the need to rethink the regulatory environment for building not just semiconductors, but also energy, including fossil fuel energy , uh, but green tech and, and all the different types of industries that need to be, we will be reshored over coming years and coming decades.
Speaker 1:Well, so perhaps then we could wrap up on another aspect of, of the papers, which talks about industrial policy. And because this does , uh, think you make the point that this is kind of a rare situation where actually it's a pretty, there's kind of bipartisan agreement on this, isn't there?
Speaker 2:Yes. So, you know , there actually are a couple areas where the two parties agree, but certainly in terms of national security issues, this is very important. There's been a couple major speeches this year by , uh, people in the Biden administration. The National Security Council has been pushing this very heavily in the New year, we will have changes in house committees and the people who look like they're behaving the Key House committees believe at least as strongly , um, on these issues as their, their predecessors did. So it , it is bipartisan and I think the CHIPS act certainly was a , a bipartisan piece of legislation, and that's important. Things like the October seven export controls, there's certainly a lot of bipartisan support for that. By the end of the year, we'll have a new executive order looks like they'll be addressing not just semiconductors, but artificial intelligence, quantum computing in , in a couple areas , uh, like that. And , and then some people are wondering, you know, what the , what will this mean for TikTok for something which is very broadly used? I don't think the National Security Council has a strong view on TikTok , but there are certainly a number of high profile GOP members who think that TikTok is a danger. It could be used in some form of influential campaign, and that we need either legislation or executive orders or other measures to, to deal with that. So <laugh> I think it's sort of funny when we actually look at TikTok content to think that this could be viewed as a national security issue, but I think it too will come to the fore in , um, the first half of next year.
Speaker 1:Okay. Well, thanks very much for joining me, Kevin. Uh , again, the , the white paper , uh, this could be upon our website shortly, if not already by the time you hear this is called Reinventing Globalization. Give it a read and uh, we'll be back with another episode of actively speaking , uh, soon. Thanks.
Speaker 2:Thank you.
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