In his report entitled “Trade of the Century”, Smith contends that the allure of populist economic positions is far outweighed by the hidden costs of protectionism, particularly as far as the consumer is concerned.
“We believe that protectionism and the prospect of a descent into a beggar-thy-neighbour global trade war is one of the biggest risks to returns over the next decade, and it’s not getting nearly enough attention,” he said. “Free trade has undoubtedly accelerated ‘creative destruction’ and the corollary is greater disruption to working lives.”
While Smith thinks a protectionist turn for American trade policy is more likely under a Donald Trump presidency, he doesn’t discount the possibility that Hillary Clinton could end up implementing more protectionist policies in order to satiate an agitated electorate and a number of her own democratic party members.
Smith notes her position on the Trans-Pacific Partnership, a trade agreement among twelve of the Pacific Rim countries, excluding China, proposed under the Obama administration, has pivoted several times already.
Whether Clinton or Trump is the victor in the upcoming election, the potentially ensuing protectionist policies would lower expected returns on US equities in the long-run, said Smith. According to his argument, protectionist policies impede productivity and ultimately leave the consumer with the short-end of the stick.
“Ignoring cyclical ebbs and flows, economic theory dictates that over the long run revenue growth is tied to economic growth (GDP). A structural impediment to productivity growth is an impediment to the revenues that can be generated in the US economy. Furthermore, […] contributions to growth from labour and capital are set to be much smaller over the next two decades, with an ageing population and an apparent slowdown of invested capital. This means that GDP growth in developed economies in the 21st century will be all about productivity,” Smith explained.
Trumped up protectionism
In an era of American protectionist ascendancy, which Smith envisions as more likely under Trump, equity investors should position themselves away from sectors with a high sensitivity to economic uncertainty, a high correlation with the US business cycle and a high proportion of earnings originating in China, he asserted.
There are many sectors that fit two or three of those categories, Smith indicated, including financial services, automotive parts, tech hardware, electronic equipment and general industrials.
Ironically, US manufacturers, the intended beneficiaries of protectionist policies, would suffer, particularly those that source component inputs from China.
Smith’s report also reveals that many of the sectors least exposed to a resurgent protectionism, such as healthcare equipment and services, electricity and food producers would start trading much higher than their historic valuations. The electricity industry could see its price to earnings ratio inflate by as much as 49% relative to the 25-year average, for example.
He warns investors that in said protectionist scenario, assets that tend to benefit from heightened US uncertainty, including growth stocks and UK defensive sectors, are likely to behave unexpectedly given their revenue exposure to China and the US, respectively.
