Russia's invasion of Ukraine has fast forwarded a shift away from the decades long trend of economic integration and globalization, and that will create both challenges and opportunities for American businesses and investors. There is by no means a clear road map to the reconfiguration of global commerce in a potentially new Cold War era. But economists say the forging of global supply chains and low-cost manufacturing was a deflationary trend, while breaking globalization apart will be inflationary. Imagine, for instance, a slow evolution that will take years or even decades to play out as companies relocate plants, rebuild supply chains, refocus product lines and rethink marketing. "It means more onshoring than offshoring. That's inflationary," said Dan Niles, founder of the Satori Fund. "This is not going to happen overnight. We spent decades putting manufacturing into the Far East. It's going to take a lot to get away from that reliance," Niles said. For some companies, "it's going to be pretty painful." For investors, there will also be unique challenges. Each company, even within the same industry, will be impacted differently by the costs and logistics of potentially relocating operations, securing new sources for supplies and maintaining a workforce at potentially higher wages. It means picking companies that are able to best withstand these headwinds or are in sectors that will directly benefit from these changes, like infrastructure, energy, materials, industrials and some technology. As companies reconfigure supply chains, countries are also expected to realign their economic and political alliances, and there will be both winners and losers. Niles said the trend has impacted how he invests. For instance, he made a call in late December to shift from the more global bank JPMorgan Chase to a domestic bank ETF, SPDR S & P Regional Banking ETF. He said he was anticipating geopolitical events would become a factor for markets. He said he anticipated a possible invasion of Ukraine by Russia and was concerned China could move to take Taiwan, something he still expects could happen. JPMorgan CEO Jamie Dimon warned this week the bank could lose $1 billion in its Russia exposure. Niles said some companies that have already made efforts to increase domestic production, like Intel, are also more attractive. "It's really going to require nimble managements that are going to navigate tariffs, the threat of tariffs, the redundancies of being in the Asia block and Europe as well. It's going to evolve slowly," said Joe Quinlan, head of CIO market strategy for Merrill and Bank of America Private Bank. "The biggest thing is the guidance is going to have to be increasingly honed in with how do you view the world? How is the world evolving to you? … How are you managing these supply constraints globally and how are you finding the demand in terms of slower growth in Europe and China." Quinlan said he expects companies will locate in specific markets where they have customers and have shorter supply chains within markets. "The U.S. is only 25% of the world's GDP and we have less than 5% of the population. No multinational can grow their earnings without the external resources. It's definitely become more challenging," he said. "My take is there's been a lot of sand thrown in the gears of globalization, but at the end of the day, companies — U.S. companies in particular — need to be overseas now more than ever. They need the resources, the human capital and markets," said Quinlan. Russia breaks world order Quinlan said globalization kicked off in the 1980s, but the collapse of the Soviet Union in the 1990s drove it even more. Another boost came when China joined the World Trade Organization in 2001. "It really blossomed in the 1990s, really up until the financial crisis," he said. Globalization made the world smaller. Airlines, hotel chains, Hollywood entertainment, consumer brands, financial services fanned out across the globe, as companies looked for new growth opportunities. American companies, particularly tech, anchored manufacturing in China and in its Asian neighbors, seeking cheaper labor and new markets. The Russian invasion of Ukraine has shown that too much integration is not a good thing. Russia's position as a commodities warehouse to the world has made its exit from global trade particularly painful. Sanctions by the U.S. and allies on the Russian financial system have thrown global commodities supply chains into turmoil. This comes as the world was beginning to repair the breakdowns in supply chains that occurred after the economic shocks caused by the pandemic shutdowns. Europe's dependence on Russian energy has resulted in skyrocketing and volatile prices for fuel and natural gas, and a global surge in oil prices. After the Feb. 24 invasion, West Texas Intermediate oil futures soared to a high $130.50 per barrel , but have since fallen back to about $97 per barrel, just several dollars above where it was before Russian troops entered Ukraine. For consumers, the oil volatility has meant higher prices at the pump. The national average for unleaded gasoline jumped to an all-time high of $4.33 per gallon on March 11, but has since come down to a still elevated average $4.15 per gallon, according to AAA . A year ago, unleaded gasoline was averaging $2.87 per gallon. Russia and Ukraine supplied about a third of the world's wheat exports and a fifth of the corn exports. Russia also dominated the world's fertilizer industry and the loss of its exports has resulted in high prices for farmers everywhere. Russia is also a major producer of minerals that are now lost from the world market. As a result, the world is in a resource scramble. BlackRock CEO Larry Fink declared that Russia's invasion upended the world order put in place at the end of the Cold War. "The Russian invasion of Ukraine has put an end to the globalization we have experienced over the last three decades," Fink wrote in his 2022 letter to shareholders . "It has left many communities and people feeling isolated and looking inward. I believe this has exacerbated the polarization and extremist behavior we are seeing across society today." But even before Russia's aggression in Ukraine, deglobalization had been underway. Some strategists point back to the financial crisis, when critics claimed globalization made the ills of the financial industry spread more quickly between international financial institutions. The Great Recession also highlighted the growing divide between the world's rich and poor and spawned protests, including the Occupy Wall Street movement. "The reality is that deregionalization of supply chains started in the wake of the financial crisis," said Diane Swonk, chief economist at Grant Thornton. "You lay on top of it the problems with China, geopolitical issues, the pandemic, climate change, extreme weather and Ukraine, and all of a sudden you have a world that is more subject to boom and bust cycles." The Russian invasion has made securing new energy supplies an immediate concern. Russia exported about 5 million barrels a day of oil, mostly to Europe, and another 2.5 million barrels a day of diesel fuel and other refined products. For the energy industry, analysts say it means more investment in traditional energy, like the oil and gas companies in the Energy Select Sector Fund . President Joe Biden has promised Europe more liquified natural gas, and that could mean more infrastructure spending in both Europe and the U.S. and a boost for U.S. companies like Cheniere , a company that exports liquified natural gas. There is also expected to be much more investment in renewable energy production, as companies look to alternative fuels to replace some of the lost oil and gas. "We own a basket of clean energy names, ICLN is an ETF," said Niles. He said he is also making investments in uranium. "That's something that's going to be given a second look as you try to get off the reliance on Russian energy." The iShares Global Clean Energy ETF that Niles holds includes names like Enphase Energy, Vestas Wind Systems and Plug Power, among others. There are also many other clean energy funds, including Invesco Wilderhill Clean Energy ETF and the Invesco Solar ETF , which focuses on solar companies. Uranium ETFs include Global X Uranium ETF and North Shore Global Uranium Mining ETF . Reshaping the world order Strategists point to the trade wars and tariffs launched during the administration of former President Donald Trump as a clear reaction to globalization. His America First strategy supported investment in American operations over foreign assets, and the Biden administration continues to promote more business investment in the U.S. Niles said, for him, there was one event that crystallized the move away from globalization. "This trend towards deglobalization started when Trump banned sales of semiconductors to China . That was the big shot across the bow. The good news is you have companies that already started thinking we need to have more domestic production, and the Chinese, for their part, said we can't be so reliant on the U.S.," said Niles. Strategists expect there could be two spheres of technology development — one driven by China and another driven by the U.S. "Russia just sort of puts another catalyst into that in terms of two separate centers for technology production and manufacturing. If you're servicing U.S. markets, you want to make sure you have plenty of availability of anything you need to produce in the U.S.," Niles said. New global alignments Jimmy Chang, CIO of Rockefeller Global Family Office, said the world is heading for a new Cold War that will have new alliances. "You're going to have three camps — the Western liberal democracy led alliance, the authoritarian actors with Russia and China as the senior partners ... and you have the non-aligned, like Brazil, India," said Chang. "Commodities, technology resources, whether it's human resources — will be leveraged for geopolitical gains." Chang said the U.S. and Europe would be aligned, while countries like Iran, Pakistan and North Korea may stay close to China and Russia. Countries may look to be self-reliant and align with governments with the same interests. "We're going to move from a world of interdependency. That was the model for the last 20, 30 years. That led to globalization, free trade, free flow of commodities, commerce," he said. "That didn't work with Russia. It's exploiting this interdependency, trying to take Europe hostage. The drive toward self-sufficiency will mean the reversal of some of the benefits of globalization." Chang said the deglobalization shift could take years. "China obviously has been the factory to the world. It's the biggest question mark and how do they evolve?" he said. A big question is how does the strategic rivalry between the U.S. and China play out. "As some of these benefits of globalization get reversed, it's going to be negative to most companies," Chang said. "If you have to rethink your supply chain and your production, costs will be higher, and I think it takes years to execute the strategy." Apple is one company to watch, since so much of its manufacturing is tied to China and the country is also a big market for phones and other products. "They've been moving some production to India, some other locations, but in the long run what is Apple's strategy? Apple could set the tone for the rest of the industry. Many other companies look to the industry leader," said Chang. "Apple has a lot of exposure to China that makes it vulnerable." For companies that move out of China, the costs could be high, but companies staying there could also pay a price. "Everyone looks at China, the second largest economy in the world being a big market, and in this new Cold War your potential market access could be somewhat limited, and it could be imposed by the American government," Chang said. Chinese President Xi Jinping's "common prosperity" program, which aimed at reducing inequality, resulted in a crackdown on China's tech and other industries. "There's still many benefits for companies that do business in China. From a business owner's perspective, you have to think about things on the margin — security, safety and confidence in trying to do business," said Keith Lerner, Truist co-chief investment officer and chief market strategist. He said the common prosperity program may be beneficial for citizens but not Chinese company profits. Chang said China is the most efficient manufacturer in the world. "You can move plants to other countries but most of them don't have the whole supply chain, the infrastructure China offers. It's going to be less efficient," he said. In the new world order, just as companies could win or lose, so could countries. "Since China was one of the biggest beneficiaries, I think that's a negative for them," said Lerner. "But a country like Mexico, they benefit. You can just look at their stock market...It's at a cycle high." The iShares MSCI Mexico ETF hit a 52-week high on April 4 and is up about 5% year-to-date, while iShares China Large Cap ETF is down more than 15% since the beginning of the year. U.S. stocks are also lower on the year, with the S & P 500 down nearly 6%. "I think Brazil would benefit in so much that they are a commodity producer. In many of these countries, there's their own policy risk," said Lerner. "I would put Mexico at the top. We're already a big trading partner. I think India would also benefit more on the technology side. They're going to benefit from the U.S. and potentially doing more business with China." The iShares MSCI Brazil ETF is up 34% year to date, while the iShares MSCI India ETF is down about a half percent since the beginning of the year but up 9.8% over the past month. On the other side of ledger, Europe could be a loser at least for now. "In the near-term, Europe is one of the biggest losers, and obviously, they face the risk of stagflation. More than 4,000 German companies have investments in Russia," said Chang. "There's a lot of very close ties. Severing or reducing those ties will have an economic impact at the same time they're seeing high inflation." How to invest Bank of America's Quinlan said there will be winners and losers within the major industries that are now the most global. "Food and beverage, mining companies, energy, pharmaceutical, technology, they're the most globalized as we speak. They're going to have challenges," he said. Truist's Lerner said companies, like consumer staples, could see higher costs as they look for new supply chains or relocate. He said companies will look to offset costs, and that could be good for companies that do cloud computing. "We are going to think, how do we offset that. Automation and AI would benefit," he said. There are ETFs that cover those themes, including Global X Robotics and Artificial Intelligence ETF and the ROBO Global Robotics and Automation Index ETF . In the new world order, Lerner also expects cybersecurity and infrastructure stocks would benefit. For investors seeking play areas, there are a number of ETFs. Cyber ETFs include Global X Cybersecurity ETF , the First Trust NASDAQ Cybersecurity ETF , and WisdomTree Cybersecurity Fund , among others. ProShares DJ Brookfield Global Infrastructure ETF and iShares Global Infrastructure ETF are global plays, while there's also a iShares US Infrastructure ETF , among others. "We're a big producer of agriculture. That's a net positive for the U.S. economy. ...That's a plus for our farm economy," Lerner said. The VanEck Agribusiness ETF is close to its 52-week high. It includes stocks, like Deere and fertilizer companies, Mosaic and CF Industries. Quinlan expects digitalization of services will increase. "A lot of stuff is going digital, services digitalization. That's the next wave of globalization. Services, technology companies, intellectual property rights. They're still going to cross borders," he said. "Whether it's 3-D printing, whether it's software coding." Digitalization will also shine a light on the growing technology divide with China. "It has a firewall around its digital economy. Between the U.S. and Europe, I think there's more harmonizing coming when it comes to digital economy. That's bullish long term," Quinlan said.
Josephine Flood | CNBC
Russia's invasion of Ukraine has fast forwarded a shift away from the decades long trend of economic integration and globalization, and that will create both challenges and opportunities for American businesses and investors.