A Sea Change: Globalization and Market Volatility
By: John Weitzer, CFA, SVP, and Chief Investment Officer
Jun 3, 2022 | 10 min. read
The world is responding to Russia’s invasion of Ukraine by taking a step back from globalization. What might that mean for financial markets?
“Nothing of him that doth fade, but doth suffer a sea-change, into something rich and strange”
- William Shakespeare, The Tempest
The world’s capital markets are currently going through a period of rapid adjustment. Inflation rates are high, interest rates are rising, bond prices are falling, and the equity markets are correcting. What is going on? Some contributing factors have been well documented: lingering post pandemic lethargy, accommodative monetary and fiscal policy, and an economic demand shock that only exacerbated an already shaky supply chain situation.
These factors seemed to be slowly resolving themselves, though, until an event with the potential to have an even deeper and more enduring impact on the global economy occurred. We are now experiencing a substantial transformation, or what is sometimes characterized as a sea change, in the global capital markets. Put simply, the world appears to be responding to Russia’s invasion of Ukraine by taking a step back from globalization.
Globalization is a term used to describe how trade (services, goods, technology, and knowledge transfer) has made the world into a more connected and interdependent place. It has benefitted many by helping to increase economic growth for more countries and encouraging global cooperation and cross-border investments. Mr. Pierre-Olivier Gourinchas, the Chief Economist at the International Monetary Fund (IMF), stated that globalization has “lifted hundreds of millions out of poverty and allowed emerging market economies to see their economies soar in the last 30, 40 years[.]”
Before I describe this sea change and its potential implications, I need to provide some background on the rise of globalization. As World War II was coming to an end, U.S. leaders assessed the devastation and came to the following conclusions:
- The U.S. emerged from the war as “the” global superpower, but it had no desire to become an empire.
- The U.S. had a golden opportunity to “reboot” the economic order of the world. Having the only relevant deep-water navy to survive the war, it alone was able to install a global free trade system, and anyone who partnered with the U.S. could sell goods and services to anyone else in the system without concern.
- Any country that wanted to participate in this free trade system would have to let Americans direct national security policies (think NATO).
Based on these conclusions, the U.S. brought their allies together at a ski resort in Bretton Woods, New Hampshire, and imposed this fundamentally new global economic system. America’s allies were relieved and quickly accepted what came to be known as the Bretton Woods Accord. They did so because they recognized that the U.S. was not pursuing empire status, but instead was proposing a solution that would benefit most stakeholders. The thought behind all of this was that if countries could access economic growth through a free trade system that encouraged cooperation and business competition, nation state wars would become a thing of the past. Nothing secures American national security better than a world at peace as a result of economic interconnectedness.
The United States military alliances and the new global free trade system were the driving forces behind the eventual demise of the Soviet Union (1988-1991) and bringing China into the World Trade Organization (WTO) in 2001. This system “ushered in the greatest era of peace and prosperity in human history. Global GDP [economic output] expanded by a factor of ten. The global population tripled. The massive, civilization-threatening wars of the past . . . all simply stopped.”
Which brings us back to Putin’s war on Ukraine. Russia’s invasion of Ukraine rejected the global free trade system and the notion that nation states can resolve their differences peacefully. The global free trade system is now transforming into something different. What does that look like?
On April 13, Secretary of the Treasury Janet Yellen presented an important speech at the Atlantic Council.
“Yellen described a new world order that is dominated by countries that play by the same rules. Countries that choose not to play by the rules will be treated as pariahs by the abiders. By invading Ukraine in an unprovoked war by choice, Russia has turned itself into a pariah nation among the “unified coalition of sanctioning countries” (UCSC). This league of rules-based countries “imposed an unprecedented suite of financial sanctions and export controls on Russia.” Yellen declared: “We, the sanctioning countries, are saying to Russia that, having flaunted the rules, norms, and values that underpin the international economy, we will no longer extend to you the privilege of trading or investing with us.”
By acting in concert against Russia, the UCSC demonstrated that the sanctions are not driven by the foreign policy objectives of any one nation, but rather in support of certain civilized principles: opposition to aggression, to widespread violence against civilians, and in alignment with a commitment to a rules-based global order that protects peace and prosperity. In the same speech, Yellen called for free but secure trade with countries the U.S. can count on, which should involve a “re-shoring” or “friend-shoring” of global supply chains to trusted countries. She reasoned that the U.S. cannot allow countries to use their market positions in key raw materials, technologies, or products to have the power to disrupt the global economy or exercise unwanted geopolitical leverage. Russia has been quickly and effectively cut off from the global system (banking, access to multi-national companies, shipping systems, etc.).
Indeed, this sea change is already viewed through numerous tectonic geopolitical shifts:
- Many global leaders have condemned Russia as a rogue nuclear power.
- Switzerland took uncharacteristic, non-neutral actions by sanctioning Russia.
- Germany and Japan, with U.S. blessing, are building up their military capabilities.
- Even nations hostile to U.S. dominance such as China, Iran, and North Korea are seemingly distancing themselves from Putin.
- NATO is strengthened as member countries began (or promised to begin) paying their annual 2% of economic output into NATO efforts. In fact, for the first time, even neutral European countries such as Sweden and Finland have expressed interest in joining NATO, which would have been unthinkable just months prior.
- The European Union (EU) has strengthened as well, due to its unified response to Russia’s aggression.
- EU and non-EU European countries have concluded that relying on Russia for a portion of their energy needs most likely is not prudent.
What are the potential implications of this sea change from an economic and investment standpoint?
- The UCSC will have better prospects. Conversely, countries outside of the UCSC, or that are at risk of being outside of the UCSC, will have bleaker prospects.
- As the U.S. is leading the UCSC response and its economy is more insular than other countries (i.e., self-sufficient, given its economic dominance based on domestic consumption), it stands to be an economic leader in the new environment.
- The world’s efforts to move from carbon- based energy sources (coal, oil, gas, and liquid natural gas) to renewable sources will decrease in intensity. The urgency toward replacing traditional energy sources with renewables will take a pause as traditional supply systems are solidified. Nuclear energy may stage a comeback.
- Even so, oil production globally will decrease as the sanctions targeting Russia, along with multi-national energy company departures (taking with them their technology, knowledge, and experience) begin to bite what is currently the third largest global energy producer. This will be supportive of high and higher oil prices.
- The UCSC will focus on building and maintaining an uncompromised energy system (one not beholden to potential enemies).
- Globalization was deflationary. Stepping back from globalization is inflationary.
- “Re-shoring” or “friend-shoring” of global supply chains (factories and energy systems) to trusted countries is also likely to have inflationary implications if it involves a move to countries with higher input costs than the departing countries.
- Russia and Ukraine produce a quarter of the world’s wheat and export it primarily to the Middle East and Africa. Disruptions in this supply chain could lead to increased instability in these areas of the globe. The last time wheat was scarce, it helped to bring about the Arab Spring, characterized by a series of anti-government protests, uprisings, and armed rebellions that spread across much of the Arab world in the early 2010s.
- Russia and Ukraine are large producers of fertilizers for the world. Reduced access to fertilizers has huge implication for world food production and, by extension, for food inflation.
Over the long term, this sea change will likely have beneficial global impacts, and maybe even turn “into something rich and strange.” Over the short- term, however, it will serve as a source of market and economic volatility. The First Command Investment Team is currently exploring this transformation and its potential implications to position investment portfolios appropriately going forward.
In the meantime, rest assured that our Advisors are trained to utilize the wide range of investment options we offer, to ensure that our clients’ investments are aligned with their financial plan and, just as importantly, to keep them from making rash decisions through inevitable periods of volatility. We at First Command value time in the market versus attempting to time the market and accept volatility as an inherent risk for stock investors, using it to our advantage to improve market returns through dollar-cost-average and opportunistic rebalancing. If you haven’t met with your Financial Advisor recently to review your plan and access your portfolio, we encourage you to do so at your earliest convenience.
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The information in this report was prepared by John Weitzer, Chief Investment Officer of First Command. Opinions represent First Command’s opinion as of the date of this report and are for general informational purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. All statistics quoted are as of the date of this publication, unless otherwise noted. First Command does not undertake to advise you of any change in its opinions or the information contained in this report. This report is not intended to be a client specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Should you require investment advice, please consult with your Financial Advisor. Risk is inherent in the market. Past performance does not guarantee future results. Your investment may be worth more or less than its original cost. Your investment returns will be affected by investment expenses, fees, taxes, and other costs.
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- The Tempest by William Shakespeare.
- Globalization | National Geographic Society.
- 6 Pros and Cons of Globalization in Business to Consider (hbs.edu).
- “Fragmentation poses ‘serious risk’ to global prosperity: IMF”, The Economic Times IMF: Fragmentation poses ‘serious risk’ to global prosperity: IMF - The Economic Times (indiatimes.com) (April 20, 2022).
- The Absent Superpower by Peter Zeihan, pages 102-106 (2016).
- Creation of the Bretton Woods System | Federal Reserve History.
- Zeihan at page 103.
- Russia is part of the United Nations and the G20 Council. Putin did not present his current conflict for discussion in front of these multi-country bodies.
- Morning Briefing by Yardeni Research (April 25, 2022).
- Same (emphasis added).
- Strategas Research (March 2022).
- Alpine Macro Research (March 2022).
- The utterance “inconceivable” from actor Wallace Shawn from the movie “The Princess Bride” comes to mind.
- Arab Spring - Wikipedia.
- The Tempest by William Shakespeare.
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