AN APOCRYPHAL quip once read that when America sneezes, Europe catches a cold. Recently, it might have been more apt to say that when Italy is unwell, the world’s temperature starts to rise.
On May 29, the S&P 500 and the Dow Jones Industrial Average registered their biggest one-day percentage drops in a month, as political turmoil in Italy led to concerns about the future of the eurozone.
However, just a day later, worries over Italy began to ease and European markets edged higher, with oil prices rallying on the back of production commitments from OPEC. In fact, a Reuters poll on May 31 predicted the FTSE 100 would end the year at 7,800 points, just shy of a new record.
Some might say it was merely another few days of volatility in world markets. But what happened with Italy underlines just how inextricably linked the global economy has become.
Not that long ago, the FTSE 100 was seen as a proxy for the UK economy. Launched in 1984, it sat at 1,000 points and was dominated by what were then household names.
As with most things in life, that’s changed quite dramatically. Some businesses have dropped out, others have broken up and plenty have been taken over. Even the companies that have survived – including Barclays, BP, GlaxoSmithKline, and Tesco – have evolved well beyond what they were three decades ago.
One of the most powerful forces behind that change has been globalisation. While many of these organisations did most of their business in the UK, that’s no longer the case. The market has become internationalised to the point where nearly 75 per cent of their earnings now come from abroad.
The increasingly global nature of our economy is reflected in investors’ portfolios too. In the 1980s, a balanced portfolio might have looked along the lines of one-third invested in gilts and two-thirds in blue-chip UK equities.
Now that would be considered far too heavily focussed on the UK. Partly due to globalisation and because gilt yields are down from returns of more than 10% to less than 2%, that has all changed.
A typical balanced portfolio might now have a little under 20% in bonds, of which only a portion would be in gilts, and there would be a range of UK and overseas equities, with exposure to North America, Europe, Japan, and emerging markets. There are also likely to be positions in alternative assets, such as commercial property, total return funds, and infrastructure.
The result is that investors, whatever their motivations, are more exposed to the vagaries of the world than ever before.
For now, that might be fine – the global outlook is relatively benign. Unemployment rates have been falling in the US and the UK, Donald Trump’s tax cuts should help the world’s largest economy, wage growth is picking up, and consumer confidence stateside is at a 12-year high. The eurozone economy has been recovering reasonably well, although growth slowed to 0.4% in the first quarter of 2018.
As ever, there are also clouds on the horizon. Brexit rumbles on and, if it goes badly, it could lead to weakness in sterling. Increased protectionism is becoming a real obstacle to growth, with the US imposing tariffs on steel and aluminium imports from countries in the EU and North America. Global debt has hit all-time highs despite favourable economic circumstances, which bodes ill for tougher times ahead.
It’s an uncertain world and we’re all wedded to its fortunes more than ever before. Whatever happens in politics, economics and markets in other countries, we will all feel the effects in one way or another.
It may seem ironic in a way, but the key to reducing risk from international affairs is to diversify investments.
Alasdair Ronald is a senior investment manager at Brewin Dolphin in Glasgow.
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