Thursday, August 2, 2018

Blackstone's Byron Wien on Trade, Politics and Markets

From Blackstone. July 30:

The Dangers of Inward Thinking
There are a number of changes taking place in the investment environment and they are likely to have an influence on the returns on financial assets for some time to come. When the world’s leading economy, with more than a fifth of global GDP, does not participate in major alliances dealing with matters of security and the environment, this has longer-term investment implications. When multilateral trade agreements are in jeopardy, earnings for companies in participating countries are likely to be affected negatively. When the number of public companies materially shrinks, investment opportunities become more limited even if the overall market value for public securities increases. When companies choose to remain private because they can raise money without a public offering, investors are deprived of sharing in the growth of some of America’s most exciting innovations. All of these examples contribute to the theme that the world is becoming a place where inward thinking is on the rise. I worry that countries and companies are thinking short-term and making decisions accordingly. While this may result in favorable quarterly earnings comparisons and temporary solutions to geopolitical problems, the long-term implications of inward thinking may be more problematic.

Let’s start with the shrinkage in the number of public companies. Today there are fewer public companies in the U.S. than at any time over the last 40 years. The peak year for public markets was 1996, when over 8,000 companies were listed on U.S. exchanges. Today that number is down nearly 50% to 4,336, according to the World Federation of Exchanges. This troubling trend isn’t just limited to the United States. The number of companies in developed markets around the world is shrinking: Canada, Switzerland, Germany, France, the U.K. and others have seen the number of listed companies fall 20%– 60% from their peak. Mergers and acquisitions played a major role, but so did leveraged buy-outs. As globalization became a more important factor, competition increased and companies became vulnerable to predators. Many sought refuge by consolidating with businesses in similar or related industries. Let’s face it: being a public company has never been fun. A company is judged by its quarterly earnings performance, which often causes it to make decisions that might not be in its best long-term interest.

Executives of public companies have to spend time talking to security analysts and holding conference calls when they could be working on matters that would improve growth prospects. Legal and investor relations expenses are also a factor. As more companies have deferred or avoided going public, the number of companies investors can choose from has become more limited.

Two basic incentives encourage companies to go public: raising capital and monetizing the value of the company for employees. Now both of these objectives can be satisfied in the private market by venture capitalists and other investors. As a result, major innovative companies like Uber and Airbnb have chosen to remain private for much longer than would have been the case several decades ago. Although the small investor has been deprived of the opportunity of participating in their growth, the companies themselves have enjoyed more flexibility in the early stages of development when their earnings are likely to be volatile; therefore, staying private is not necessarily an example of inward thinking or short-termism. It may be a sound business decision.

For most of the post–World War II period the world has forged constructive trade agreements that have enhanced the globalization process. Arguably, this trend started with the General Agreement on Tariffs and Trade (GATT) in 1947, when the average tariff rate between participating countries was 22%. But with each successive treaty, including the North American Free Trade Agreement, the European Union, the proposed Trans-Pacific Partnership and others, average rates around the world drew closer to low single-digits. The U.S. saw its tariff rate fall from a high of 30% in 1918 to a low of 1.3% in 2010. The current trade confrontation between the United States and its trading partners around the world represents a potential reversal of that trend (see chart below).

Avg US Tariff Rate
Estimate as of 6/30/18. Source: Blackstone, USTR.
In the past, disagreements among countries over trade issues have been negotiated peacefully, but now it appears that a more hostile atmosphere exists. If it persists, the total volume of world trade is likely to be reduced, negatively impacting growth, job creation and return on investment. While there is no question that imbalances exist and attempts should be made to correct them, all the participants are likely to suffer if the approach is severely adversarial. Although the Trump administration pulled away from designating China as an “unusual and extraordinary threat” pursuant to the International Emergency Economic Powers Act and endorsed less onerous amendments to the Committee on Foreign Investment in the United States provisions, our relations with China, our most important trading partner, remain strained. Currently, $50 billion in tariffs have been imposed by the White House, with another $50 billion announced. There could, however, be as much as $675 billion more if the current trade conflict escalates. Despite this being less than 5% of the service-oriented economy GDP of the U.S., the impact on certain industries and countries could be significant. The global turmoil in trade is likely to have an impact on corporate revenues and profits that will become evident in 2019. Even without the trade impact, year over year comparisons are expected to be difficult next year because of the strong earnings performance in 2018....MUCH MORE