HDRO - The Global Events To Watch In 2024 And The Implications For Markets

2023-12-12 04:14:00 ET

Summary

• How elections in Taiwan and the U.S. could dramatically reshape relations with China.
• Why globalization is changing in ways not seen in decades.
• Onshoring and the impact on manufacturing.

From geopolitical conflicts to market volatility, there has been no shortage of news and events for investors to consider this year. Kevin Hebner, Global Investment Strategist at TD Epoch, discusses the issues most likely to be meaningful in 2024 and why investors should “prepare to be surprised.”

Transcript

Kim Parlee: From geopolitical conflicts to market volatility, there's certainly been no shortage of news and events for investors to consider recently. But when it comes to what to expect in 2024, my next guest says, prepare to be surprised. Kevin Hebner is Global Investment Strategist at TD Epoch, and he joins me now.

Kevin, always a pleasure to have you with us. I don't know if that's a good thing or a bad thing that we're going to be surprised in 2024. But let's just maybe go through the list of things that you're watching and that we should be thinking about in terms of being surprised. And the first one is the Taiwan election. Tell me why this matters first off, and why you're watching it.

Kevin Hebner: OK, I guess in terms of background, we're fundamental investors. We're obsessed with free cash flow, return on invested capital, their sustainability. But even from that perspective, it's important to be thinking about risk on the horizon, different policy changes that could happen.

And as Ian Bremmer said yesterday in his 2024 outlook, the geopolitical risks are higher now than they've ever been during his lifetime. So fundamental investors need to be thinking about these. 2024 is going to be busy, lots of surprises we think. And the first one on the calendar is the Taiwan election in five weeks.

There are three parties that are running. The current government party is leading a little bit in the polls. And they have a bit of a leaning away from China. The number two party, the KMT, wants to move a little bit towards China. And these can be important, but the real risk with the Taiwan election is that there is a mistake that gets made, that someone makes a statement that China interprets this as moving toward independence, and China gets upset with that.

And so, it's an important election to watch not for the bread and butter issues that they're running for, but how the policy towards China changes and the possibility of a mistake occurring.

Kim Parlee: And if there's a mistake that occurs. And again, I know you're not going to prognosticate and try and predict the future, but if China perceives that there's a move towards independence, I would just that would be an escalation in that relationship and what that could mean.

Kevin Hebner: Yeah, that is a big red line for China. And I think bad things could happen in that situation. And that would certainly be terrible for Taiwan. It'd be terrible for global markets and the global economy as well.

The other factor that's going to affect Taiwan later in the year is if President Trump ends up winning the election, he's promised a major arms deal, a major arms shipment towards Taiwan. And that is also something that China isn't going to like very much. So there are a couple events during 2024 in which we have to watch the relationship between Taiwan and China, and how that develops.

Kim Parlee: Well, you mentioned the US election. I mean, obviously, it will impact what's happening with China and Taiwan, given who's president. But what else will you be watching in the election?

Kevin Hebner: So currently, the election is exactly 11 months from now, and a lot can happen over 11 months. And certainly, that's been the case with previous elections. But if it was held today, according to betting sites, Trump would win 54% versus 46% against Biden. So at least right now, Trump is in the lead.

And he's been very detailed this time. If you look at his website, donaldjtrump.com, in terms of the proposals on his platform, one is a call for tariffs, 10% tariffs across the board, universal. And that's something he can do without Congress. A second would be tax cuts, similar to the tax cuts he enacted in 2017.

A third would be a big change in policy towards energy. So he's against subsidies and regulations favoring green energy. He, on the other hand, wants to favor oil, natural gas, wants to get out of the Paris Climate Accord, these sorts of things.

In terms of policy with China, he certainly is a hawk. Policy would be erratic. And things like Taiwan, he would certainly favor close relationship with Taiwan and a major arms deal. And there's a number of other policies that he would-- at least if he gets elected-- that he said that he would like to enact.

Kim Parlee: What about the Fed? Because of course, he would get a chance to weigh in on who replaces Jay Powell, I think in what, May 2026?

Kevin Hebner: Yes. So it's still a long way away. But Trump has been very clear that he would not reappoint Powell, and that he would like someone who's loyal to him. And Trump certainly has a strong preference for low interest rates. So he would try to get someone who's going to be quite dovish in pushing interest rates low.

But overall, when you think of Trump, there may be a visceral reaction to Trump and the way he says some things. But if you look at the combination of deregulation, tax cuts, and fiscal expansion because there are very aggressive industrial policies that are associated with a Trump administration, it's not clear that's bad for the S&P. In fact, there are some sectors in which it hurt, but overall, probably good for the S&P, challenging for the dollar, probably also challenging for bond markets. But for equity investors, important, lots of sector rotation, but overall positive in the same way that markets reacted positively to the Trump election initially in 2017.

Kim Parlee: I still get nervous when you said those 10% tariffs on all imports being a Canadian, Kevin. But we'll come back to that. Listen, I know that the global conflicts on your radar, Israel-Hamas, we still have Russia and Ukraine, potentially something happening in China. I was going to move past that a little bit to say, that's something in the mix, but maybe you could just talk a bit about how globalization is changing. I mean, we know there's a path to deglobalization. You're the one who told me about it. So how do you see that moving in the next year or so?

Kevin Hebner: Yeah, so it's a big theme that we've been looking at for the last eight years. You had the period from 1990 with the dissolution of the USSR until around 2015, hyper globalization, American hegemony, America rules the roost. And trade was in hyperdrive.

Since then, we've really been playing the movie backwards. And we've seen this in terms of trade flows, FDI, portfolio flows. So we're de-risking the global economy. There still will be a lot of trade but changing the nature of trade.

For example, China, part of their growth strategy is to increase exports. But those exports won't be to the developed world. They'll be to what's called the Global South, other emerging market countries. So I think the de-risking of the global economy is important. There are lots of areas where supply chains are fragile, where they're risky, and they need to be strengthened.

And industrial policy in the United States and other countries has been very aggressive after having been non-existent for a long time. And whether we have a Biden administration, or a Trump administration after the next election, we're going to see a lot of areas where industrial policy gets moved into I think, turbocharged territory.

Kim Parlee: And you talked about Taiwan, US election, changing globalization conflicts. And you're talking about how it really is going to change economic flows, markets. And you've got a few charts here. And I want to bring up the first one, talking about the implications of this deglobalization, the friendshoring. So this is an interesting chart. Tell us what we're seeing here.

Kevin Hebner: So this chart shows imports. And the US is now importing more from Mexico. In fact, with last month's data, more from Canada as well than it is from China. And that's a very different trend than we had five or 10 years ago, where imports from China were increasing, accelerating, in way more than any other country.

And we've seen the same not just in imports in the US, but also if you look at foreign direct investment into China, that's actually falling into negative territory, so Western companies are not investing into China anymore. And then if you look at portfolio flows from China into Treasuries, and other assets, those have declined markedly. So it's trade between China and the US, that nature of changes has changed a lot, as well as foreign direct investment, real assets by American companies and other Western companies, and portfolio flows, including importantly, Chinese money into Treasuries.

So this isn't just talk about de-risking. This is in the data. And we can see it in lots of different data series already.

Kim Parlee: It's fascinating to see if we could extend the data series to see where it goes in a year or two years. I mean, it is fascinating. Tell me, what sectors are the most impacted by the trends you're seeing?

Kevin Hebner: So there are six sectors that we've been focused on. One is semiconductors. And that's the one that's most critical to de-risk. And that's also the one in which China is targeted by export restrictions from the US. And that's because of the military applications, for example, hypersonic missiles that semiconductors can be used for.

A second one is energy. And especially with the Russian invasion of Ukraine, we've learned that energy security is always critical to national security. So that's important.

A new one is AI just over the last year. And AI is a new battlefield between the US and China. The US is investing more than any other country in AI, as this wonderful venture capital ecosystem. But China's also been very aggressive and is certainly going to challenge the US dominance in this area.

A third would be the EV value chain, so electric vehicle value chain, from lithium refining, to batteries, to EVs themselves, solar panels, and so forth. China is by far dominant in this sector. And that's going to cause a lot of tension and fragility in global markets. Defense spending, everywhere in the world, given that we have two ongoing conflicts and one potential conflict, defense spending is increasing pretty dramatically.

And then the sixth sector we're focused on concerns the US dollar-based global financial system. Given the increased use of sanctions against China, Russia, Iran, and so on, the countries that are aligned with China want to come up with an alternative financial system to reduce the reliance on the US. And there makes it very easy for the US to weaponize the dollar and impose sanctions. So there are more sectors than those, but these are the six areas that we've been focused on.

Kim Parlee: Yeah, each one of those is a two-hour conversation, Kevin. But I know you have a couple of charts here I wouldn't mind bringing up. One is taking a look at energy transition investment in 2022. Why are we looking at this chart? What caught your eye?

Kevin Hebner: So in this one, in terms of the transition from fossil fuels to green energy, China is by far leading the rest of the world. And I mentioned all the different elements of that, from lithium refining on down. And so this is going to be important, because whoever's in the White House next, we are eventually going to be phasing out fossil fuels, and we're going to have this reliance on China.

And the history of these things is, countries do weaponize their power. We have this weaponized interdependence. So it's unhealthy reliance on China. And it means other countries need to be thinking about the supply chains, and friendshoring, onshoring, making sure that they have production capabilities themselves and are not reliant on China.

Kim Parlee: And let's pull up-- just speaking of the supply chain, taking a look at the EV supply chain you were talking about. This one, taking a look at global market share. Again, what should we be paying attention to here?

Kevin Hebner: So in this case, it just shows that the main companies producing batteries for electric vehicles are Chinese companies. There are also some Korean companies and a Japanese company. But it's very much dominated by China. They're way ahead in technology and in production. And the US is lagging. Europe is even lagging in this regard. And as we move through this transition, it does create this dependence and this vulnerability that's unhealthy, particularly in the world where we are in a bipolar world and the issues are becoming larger.

Kim Parlee: Is there-- just to finish up Kevin, we've got about a minute-- but I know that you talk about maybe perhaps investors may need a new mental model to navigate 2024 versus what we've had for the past decade. What do you mean by that?

Kevin Hebner: Yeah, that is the most critical point. So we're fundamental investors focused on free cash flow, return on invested capital. And the normal way that we think is we base our experience on what's happened over the last decade or two decades. And our view is that this is not going to be a great guide, and there are going to be blind spots if you do that over the next decade or so because the nature of inflation, interest rates, labor costs, and the sector distributions will be quite different.

So we do need a different mental model, not an overreliance on what's happened over the last decade or two. And that's true whether you're a fundamental investment or a quantitative investor in which you've trained your data on what's happened over the last decade or two. So this new mental model for thinking about investing over the next decade or so I think is critical.

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