We are living in a less global, more insecure and inflationary world than at any time since the fall of the Berlin Wall in 1989. The Wall’s collapse signalled the start of the globalisation phenomenon that dominated the world economy and underpinned stock market performance for more than two generations. It spurred economic reforms, liberated markets and increased trade and investment across Europe and beyond.
A dozen years later, China's inclusion into the global trading system in 2001 accelerated the development of an even greater integrated globalised economy under the auspices of Pax Americana.
Countries were soon able to exploit their comparative advantages and companies could optimise their cost base by effectively moving manufacturing to lower-cost areas, while developed markets became more services-orientated.
This was all a boon for the global economy. It led to globalisation and worldwide supply chains, which resulted in greater efficiency and higher productivity.
These two momentous events created a prolonged period of favourable structural dynamics for investors as a significant amount of cheap capital came on stream. Meanwhile, the relatively calm economic period that followed allowed governments to spend money elsewhere as inflation and bond yields declined.
Consequently, when the global financial crisis erupted in 2008, central banks were able to implement unorthodox policies to navigate the turmoil without the fear of stoking inflation.
While this was desirable from an economic point of view, it created imbalances and societal pressures by allowing economies to pursue their comparative advantages and companies to reduce their cost base.
This dynamic was compounded by policymakers cutting interest rates to zero and deploying round upon round of quantitative easing, which pushed up asset prices and benefited those who owned them. The effect was to denude the living standards of the least well-off – the very discontent that president Donald Trump is now capitalising on.
President Trump campaigned vociferously on a platform of disrupting the status quo. Geopolitically by threatening the breakdown of the post-war rules-based international relations system; economically by challenging globalisation with the resurrection of protectionism; and in currencies by putting into doubt the status of the US dollar as the world’s reserve currency. Each marks a seismic shift of direction if seen through to the conclusion.
Today, we are witnessing the rise of populism, isolationism and greater geopolitical conflict. At the same time, bond markets have corrected materially with government bonds now looking more attractive than they have for some time while equities, arguably, remain fully valued.
The valuation of the US market, in particular, has been stretched in absolute terms and relative to government bond markets. This is at a time of economic and political uncertainty.
The US equity market represents about 70% of the global index and the ‘Magnificent 7’ stocks around a third of that. The pain of a reversal of these trends could be material to both investors who are over-exposed to this dynamic, as well as the US economy, as declining wealth saps confidence and discourages spending.
The recent market volatility serves to remind investors we are in a world where valuations remain elevated and economic uncertainty is animated. The potential impact of higher tariffs on the global economy, especially in the context of a fully valued US market, hasn't disappeared.
Yet, while US trade policy may have been the catalyst for this year’s volatility, the reality is that tariffs represent just one part of a broader structural shift that has been happening for some time.
Many of the benefits experienced after the fall of the Berlin Wall – such as access to cheap capital, falling inflation and the rise of globalisation – have been steadily declining, making for a less than favourable economic backdrop.
Given president Trump appears to change his mind at will, it is somewhat thankless to make too many predictions about what may or may not happen. But we believe his protectionist stance makes a recession in the US more likely, which could lead to a rapid repricing in capital markets.
Now is a time for caution. Investors who have seen substantial returns over the past 10 to 15 years might want to consider putting the current market backdrop, and the prevailing uncertainty, into perspective.
James Harries is co-fund manager of STS Global Income & Growth Trust. The views expressed above should not be taken as investment advice.