“They took our jobs!” was a rallying cry of many who saw their jobs displaced by the growth of global outsourcing that started in the early 1990s and lasted until the Great Recession. Today, the risk of being displaced by cheaper overseas labor has somewhat subsided as the U.S. trade deficit has gradually narrowed. The trade deficit as a percent of GDP was steadily increasing from 1992 through 2007, reaching a peak of 6% of GDP in 2007. It now sits at 2.3% of GDP.
The narrowing of the U.S. trade deficit is an indicator of the future development of the world economy and has major impact on how you need to think about your portfolio.
In the 1980s and 1990s, Japan and China, respectively, transformed Asia into the factory of the world. These countries grew at phenomenal rates by exporting goods to the U.S. while suppressing consumption at home. The short-term results were tremendous: faster growth rates for Asia and lots of cheap stuff for U.S. consumers.
Over time, the bargain created imbalances in the global economy: Massive Treasury holdings by Japan and China manipulated currency values and artificially lower interest rates, which contributed to the housing bubble. The Great Recession demonstrated that these imbalances could not be sustained—and the shrinking of the trade deficit is the most tangible sign of how these imbalances are correcting.
While the correction of these imbalances is certainly a good thing for the stability of the global economy, the change in the way the world works has a serious impact on how you should consider positioning your portfolio:
- Keep your eyes on increasing foreign currency, geopolitical and economic risks. U.S. companies are exporting more, which means more of their earnings are subject to overseas risk; according to a recent study from S&P Dow Jones Indices, over 45% of the S&P 500 sales come from overseas. Qualcomm is based in San Diego, but 94% of its sales come from its Asia unit. Or take Avon Products , based in New York City: 85% of Avon’s sales come from abroad, with its largest segment being South America. The demand from abroad explains some of the recent strength of the U.S. stock market and we expect this demand to continue to grow. Investors, however, need to be aware of how much foreign currency, geopolitical and economic risk they are now holding in their portfolios.
- Consider aligning your portfolio to potentially benefit from rising emerging market domestic consumption. Emerging market growth is shifting from export-based to consumption-based. In the past, Chinese growth was predicated on building infrastructure and selling cheap goods to the U.S. Today, China’s growth is based on selling more goods to people in China and raising the average Chinese person’s standard of living. That’s not just good news for people living in China; it’s also good news for the U.S., because they are buying more products (think the Apple announcement to create a gold version of the iPad) from U.S. companies. Investors may want to shift some of their emerging market investments from commodities and exporting firms to companies that serve the domestic population. Of course, international and emerging market investing involves special risks, such as currency fluctuation and political stability, and may not be suitable for all investors.
- Protect against higher long-term interest rates in the U.S. Since emerging markets aren’t exporting their way to growth, they won’t have all the extra dollars they used to—dollars that used to end up getting socked away in U.S. Treasuries. The result is that Treasury rates, when they revert to normal, will likely be higher than they were prior to the crisis. While it could be some time before rates get back to normal, don’t expect the Chinese to finance U.S. Treasuries any longer.
The shrinking of the U.S. trade deficit is a sign that the economic imbalances of the past are shrinking. The result will hopefully be that the global economy becomes more stable. However, the world has changed—and you need to make sure your portfolio has changed, too.
–The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.