Kevin: The end goal for much of this is to eliminate chokepoints, the vulnerabilities of the United States to semiconductors, to pharmaceutical oils, to drones, to batteries, to electric vehicles, autonomous vehicles, the all the physical aspects, including physical AI, critical for the economy and also the defense capabilities of the U.S..
Ingrid: Hello and welcome to this episode of TDAM Talks. Yet again, we are going to be focusing on the global economic upheaval that is underway. I am thrilled to be joined again by Kevin Hebner. Kevin spends a lot of his time focusing on the global landscape, helping us navigate the quite volatile and unpredictable environment that we are focusing his insights on U.S. policy and the impacts globally.
I have been shared through multiple publications and with clients all around the world. Today, he's here to shock us and to question what we think about issues like home sharing, trade wars and the true cost of a weaker dollar. Kevin, your latest whitepaper, The New Global Order Implications for Investors, explores really seismic changes in global relationships, geopolitical strategy, currency, and it's reshaping a landscape at a speed that we've never seen before.
How do we break it down? So maybe we start off with the paper and what are some of the big themes that you're thinking about?
Kevin: So, the big theme is the U.S. is stepping back, stepping back from its role as the global hegemon. Hegemon is a polite word for empire. And at some point, the empire feels the costs are too high. And so, Britain did this 100 years ago. The U.S. is doing it now. In particular, the costs include being the global policeman.
So having troops and aircraft carriers everywhere causes too big. They want to step back from the role. Second role is supplying the U.S. dollar, the global currency, the global banking system. They feel that's too expensive because it's driven the dollar up and they think that's a key reason for deindustrialization of the United States rising in income inequality and things like this.
And then the third area they want to step back is the global consumer of last resort. So, if a country like China or Germany or Japan is producing too much, they want to dump their exports somewhere. It goes to the United States, leads to deindustrialization and a number of imbalances. So, the US is saying that enough's enough. We want to step back from all of these things.
And that drives a number of policy priorities for the Trump administration.
Ingrid: It's interesting that you say stepping back, the gears are really reeling some days when we watch the headlines that the administration is trying to step in to and control everything. But maybe we'll talk a little bit about this, this concept of the shifting global order for the winners and the losers and sort of what is the new reality like?
Ingrid: How does this actually play out?
Kevin: Yeah, So China is core to this. And so, people spend 90% of their time talking about Trump and tariffs, but it's 90% about China and technology. And so, it's the rise of China challenging the U.S. on the three domains of power economy, tech in defense. And that is really critical to this. And so, in terms of winners and losers, the big winner from the period of hyper globalization that preceded what we're going through now was China, as well as other countries with big current account surpluses.
So, Japan, Korea, Taiwan, Germany. So, they're the ones who are losing because they have a demand shock. For example, about 3% of Chinese GDP comes from exports to the US. That clearly is going to be decreasing going forward. So, it's a real demand shock for them. There's a bit of a demand shock as well as a supply shock for Canada and Mexico as well.
So, a lot of countries have to adjust to this.
Ingrid: It's not just a to play our game, though. Like when we think about this idea of the shifting global order, can you talk a little bit about Europe in that context as well?
Kevin: Yeah. So, 90% of it is about China. The US-China relationship and how you have the rising power, China challenging the established power of the United States. And this has happened over and over in history. So many of the same themes are coming through. But there are other regions. The EU is another region, and some people think that this provides an opportunity for the EU to step up.
We would love if that's true, but our reading of this is that's not happening. And in fact, this was a key theme of our investment policy group meeting yesterday. Can Europe step up? And ultimately the view is that you have a country like Germany, which is the core of Europe. post-World War two. Germany did a lot of very innovative things, became the leader in industrial chemicals, autos, a number of sectors.
But there's a real stake, as I said, into Germany, and they haven't been able to adapt, for example, to the digital age. Germany has basically one leading tech company in Germany, in Europe have had these three big shocks from the rise of China, Russia invading Ukraine, and now U.S. stepping back from the position of a hegemonic empire. And you like to think that Europe could step up, but it doesn't seem to be happening.
Fred Mertz His cabinet is colorless. They don't really have any clear objectives. There's no reason to believe that they're going to be stepping in with the void and have real insights on how to position themselves to the new global order.
Ingrid: We talked about in reading your White Paper, the things that really struck me was the incredible rise of China's dominance in manufacturing globally. Right. And output. And you talk about the concept of home sharing. Can you talk a little bit about what is home sharing and how realistic is it for the U.S. to really bring home so much of this manufacturing?
Kevin: And so, when we're talking about China's rise, there's the three parts the economy, manufacturing, as well as tech and defense. And I think we should also talk about the other two, because I think they're sort of underappreciated in terms of manufacturing. China has had massive subsidies, and that's what's driven their manufacturing dominance and their policies to dominate the industries of the future.
So that could include batteries, drones, electric vehicles, autonomous vehicles, robots, a host of areas. And so, it's causing a de-industrialization of most Western countries, not just the United States, but a host of these. So, can the United States and Canada and other countries put policies in place to re industrialize? I think the answer is yes, with a couple caveats.
Ingrid: But how fast?
Kevin: Yeah, well. Well, one reason to say yes is if you look at semiconductors, which is one of the key choke points over the last four years, we've seen investment in the construction of manufacturing facilities go up 12 X in the United States. So, four years, up 12, it was averaging about $10 billion a year, really for about 30 years.
And now we're over $120 billion a year. So dramatic improvement there. And overall, the U.S. investment in manufacturing capacity, historically, it's been about 1% of GDP during a period of hyper globalization. It went down by about two thirds. Now we're back up to the historical norm. So, this this can happen. The question is, can it happen in 3 to 6 months so the United States can make smartphones, laptops, video game consoles, everything, because they have historically done that.
But the transition is going to be difficult. If you had a 5-to-10-year time frame, for sure, if your timeframes 3 to 6 months, no, that's not going to happen.
Ingrid: Is it the supply chain? Is it the cost? Is it all? What is it that makes it so difficult to do that?
Kevin: Yeah. So, it's an extremely complex, efficient but fragile supply chain. So, for many of these goods which have now Social Security implications, some of these are in technology like semiconductors, but also for Europe, there's energy in health care, there's active pharmaceutical ingredients, as we found during COVID. So, there's a host of things. Apple started offshoring their complex supply chain 25 years ago.
In fact, even before the iPhone came out. So, it used to be done domestically in the United States. They have actually, in the last five years, changed a lot of their production and doing more and more in India. But that can definitely be home shored, either while home short or friends short being sent to allies. And it looks increasingly like India is an ally.
Kevin: But other countries as well. So, I think this is in play, but it's complex and it takes a long time.
Ingrid: I get the principle of it. Are these the jobs that Americans want, and can it be done at the same kind of price point? Right. It feels incredibly inflationary.
Kevin: Yeah. So certainly, say from 1990, the focus has been entirely on economic efficiency. Lowest cost sourcing for everything. And so that's been good at some level. But this period of hyper globalization and free trade created lots of vulnerabilities and choke points. And these are great concern to China. And a real focus of policy in China has been to make sure that they have domestic production, that they don't have these risk and vulnerabilities.
The United States, Canada, other countries have legs up process. But I think people realize now, given the experience with COVID, the Russian invasion, Ukraine, the increasingly adversarial relationship with China, that we need to reduce these choke points. So, I think that's critical going forward.
Ingrid: And I spent some time on sort of the tariff wars, the currency wars, the impact on the stock market. We're recording this podcast middle of May, just days after progress was made between the U.S. and China, but not before a lot of I want to see damage. Actually, markets are kind of back to where they were. Was this dramatic reproach required?
Do we think things are calming down? Was this do we have to sort of tossed the whole apple cart or to get to where we are now?
Kevin: So, one frustration of U.S. trade negotiators in previous administrations has been they go to negotiate with China or the EU or even Canada, Mexico, and they often feel they don't have any leverage. So, they talk and talk and talk often for weeks and months. And then of the day they don't get anything done. So, they did. It was to have these threats of tariffs brought up to give them leverage so people would come.
And we have seen in a short period of time the contours of trade deals with the U.K., with China. India is probably next, but there's 15 countries they're focused on. So, will this get the contours of a deal? And the process for negotiating more details about trade arrangements with a host of countries, but it typically takes 18 months to get a trade deal.
So, this is happening very quickly. And so maybe in a perfect world, we would have had to throw overthrow the apple cart. But it's definitely got people's attention and it has got the desired results.
Ingrid: You quote George Bernard Shaw.
Kevin: Yeah. So, Shaw says that the reasonable man adapts himself to the world, The unreasonable man insists on trying to adapt the world to himself. Therefore, all progress depends upon the unreasonable man. Trump certainly portrays himself as the unreasonable man. But if you're reasonable, instead of all we're going to talk to people, we're going to set up all these committees, all these task force.
They're going to all report to us in 18 months, and then we decide what to do. Nothing would ever get done. And that's the process of decision making in the EU. And so, nothing gets done there. And so sometimes you need a person like a Trump or person like a Churchill, someone who is the unreasonable person.
Ingrid: It's fascinating to hear you say that. But you're right. I mean, it's been incredibly uncomfortable since Liberation Day, and it's felt like chaos. But coming from chaos is progress. So, let's go a little bit further on the Trump's administration, on the dollar. Where does he want the dollar? Some of the things become counterintuitive here.
Kevin: Yeah, so we were talking about the sort of three global public goods that the U.S. has been providing, global consumer last choice, global policeman. The other one has been the global currency. And the idea being with the dollar being the dominant global reserve currency, if a country like China, for example, wants to have a lower limit, be what they do, sell their currency and buy U.S. dollars, that means Treasuries driving the dollar up.
And currently, I think it's fair to say that the US dollar is roughly 20% overvalued. And a lot of it is because of these capital flows. And this is something that previous thinkers like Keynes talked a lot about and that you would need to have restrictions in capital to prevent this sort of thing from happening. So, the Trump administration and a number of his key trade advisers think that this is a key driver of the deindustrialization of the United States.
Income inequality, all these imbalances. So, they do want to have policies in place to discourage capital inflows, to discourage people buying treasuries and driving the dollar up. So, I think a high conviction view would be by the end of Trump's second term that the dollar, U.S. dollar is considerably lower than it is today.
Ingrid: 20%. I'm sorry. I mean, I've seen your charts that said compelling. Same. And when you look at the long term, let's talk about the bond markets then and what that means for sort of short-term rates administered rates, the U.S. cost of borrowing.
Kevin: Yeah. So, economists estimate that the reserve currency role of the US dollar results in the yield curve being lower than it otherwise would be by 25 to 75 basis points. So, call it 50 basis points. So, if Trump is successful in discouraging capital inflows, you should expect the yield curve to be so 50 basis points higher, the Treasury curve, and then everything that's priced off it in turn to be 50 basis points higher.
So that's that would be, I think, a natural consequence of this.
Ingrid: What does that do for the US funding? It's, you know, deficits and its borrowing costs, etc.
Kevin: So obviously, obviously, given the size of the deficit, over 2% of GDP and so forth, this is a real issue going forward. But I think the priority of the administration now is to have more balanced trade, to have re industrialization. And the end goal for much of this is to eliminate choke points, the vulnerabilities of the United States to semiconductors, to pharmaceuticals, to drones, to batteries, to electric vehicles, autonomous vehicles, the all the physical aspects, including physical AI critical for the economy and also the defense capabilities of the U.S..
Ingrid: You talk about an optimistic and a pessimistic scenario. Can you sort of lay those two out? And then I want to go a little bit deeper. We've talked about currencies. We talk about fixed income markets, but I want to talk about the stock markets globally. What are institutional investors asking you about? But let's start because I know you talk about the optimistic, pessimistic view of the outcomes here.
Kevin: So, the optimistic view, it really hinges on the state capacity of the U.S. and the competency of the Trump administration. So initially we started with tariffs. So that was to get people's attention, to get to step two.
Ingrid: Which come to the table through the Apple card.
Kevin: Which is where we are now, trade, trade deals. And then once we that be the focus for the next 3 to 6 months and then we move on to tax cuts. And so, we're getting some clarity on tax cuts in addition to just extending the Tax Cut and Jobs Act from last decade. It's going to be $4 trillion over a decade.
That's going to increase GDP in the US next year by almost a percentage point. It's huge. So, tax cuts would be next and then the focus will turn to deregulation. Deregulation in lots of areas, including a high energy finance construction, nuclear power, lots of different areas with the idea that it's time to build and we need to get regulations out of the way of this.
And then the focus probably later on would be policies regarding the US dollar. But the notion we started off with tariffs, which clearly is not growth positive, but now we've moved on to the pro-growth agenda of the Trump administration. And much of much of this is pretty vanilla for Republican administration. So, the optimistic scenario is that Trump can proceed through that agenda in a relatively smooth fashion.
Kevin: All the stuff is hard.
Ingrid: The hyperbole is coming down.
Kevin: Yeah. Yeah. So that's the optimistic case. The pessimistic case is that Trump continues to treat allies even worse than he treats adversaries. The tone remains one of belligerence. We never really move beyond tariffs to trade deals, and he has a hard time getting any of his other legislation. Well, parts of his agenda put through or put in legislation like tax cuts and so forth.
So, we end up with a repeat of April, rinse and repeat. We just keep going through that. Lots of volatility, lots of uncertainty. We get a chaotic breakdown of global trade. We get the rise of competing currency blocs and it's unstable. It's a mess. That's the pessimistic case. I lean towards the optimistic case. I don't think Trump is super mad, but I don't think he's George Costanza either.
I think he can actually get things done. I'm not a Trump voter. I didn't vote for Trump. I'm a registered Democrat. But I think one has to look at his track record. He's won a couple elections. He's actually had real wins. He's built $1,000,000,000 business. I think they have the ability to get some of their objectives done. Not all of it, but some of it.
And I think that puts me in the more optimistic case.
Ingrid: So, sitting where we are today, you know, from Liberation Day 2015, 20% sell off. We've actually recovered most of that with the exception of the U.S. dollar. In your optimistic case. What is your overall outlook for U.S. and global equity markets over the next six, 12, 18 months?
Kevin: Yeah. So right now, the S&P is up small year to date. But I think as we go through.
Ingrid: The last six weeks didn't happen.
Kevin: Yes. Yes. And so, I think as we go through the agenda, I think much of this is positive for equity markets. I think it's good for companies. It's good for companies return on invested capital, which is ultimately what drives equity markets forward. So, I think tech does well. That's where the bulk of innovation is. And even if you look at the Meg seven x, Tesla trades on a forward P of 25 times, it has a kegger for earnings growth over the next three years of about 13% has extremely high return on invested capital.
Kevin: So, I think it does deserve a premium. But overall tech I think makes a lot of sense. I also think it makes sense to diversify beyond the United States into other markets, particular where they have global champions with real moats, with strong return invested capital in shareholder returns. It's important, I think, to carefully watch your U.S. dollar exposure and to hedge that carefully.
Really, since 1990, equity managers haven't had to think a lot about the U.S. dollar, except for the short period after the tech bubble collapsed from 2000. But I think now it's something that needs to be a deliberate part of the investment process for Canadian.
Ingrid: Right. And, you know, your base and for our listeners, Kevin is based in the U.S. So, when you think about the U.S. investor, the currency conversation isn't top of mind. It is relative to global. But as Canadian investors who have large exposures to the U.S., I think you're what do you saying to institutional investors about hedging strategies, etc., from where we are today?
Kevin: Yeah, So what I try to say is it needs to be a deliberate process and where, say for the last 20 years, if you've had U.S. dollar, U.S. dollar exposure through equities or other instruments, you've just let the currency run because on average it's benefited you. But I think the risks now are very much two sided. In fact, I think they're asymmetric to the downside with the US dollar.
So, whether you're putting a 50% hedge on or 100% or you're over hedging, you need to be thinking about that. It needs to be the result of a deliberate process. Also, don't be tactical with currencies. I've spent five years working on the big, biggest FX (Foreign Exchange) trading floor in New York. You don't want to be competing against that. So make a decision, put in place, maybe adjusted a couple times a year, but don't try to de trade.
Ingrid: Don't try to outsmart it. No, I want to pivot away from the markets a little bit for a moment and talk about the future of multilateral organizations, NAITO, the Trade or World Trade Organization. How do we think about that? Like how much disruption and what does it mean?
Kevin: Yeah, so if you think about the four characteristics of the new order, one is we're in a bipolar world. We used to be unipolar, we used to be in hyper globalization, free trade. Now we're in a world of trade, wars and tariffs. We were used to be in a world of Pax America, the American peace. Now we have a lot of military geopolitical conflicts.
The fourth part is we used to be in rules based multilateral organizations. Now we're moving to America first, Canada first, and so on. So, with that, what does natto mean? 64% of funding for NAITO has been from the United States. That's clearly unfair. NAITO leaders are meeting in the next week and the view is that they're going to be increasing their commitment to defense spending from 2%.
Kevin: The feeling was 3%. There's a lot of discussion now about 5%. Canada's about one and a half. So, this has real implications for Canada's spending going forward. And this is a goal 5% by 2032. So, it's still a few years from now, but it's a pretty serious thing. Now, the issue with NAITO is the United States views China as an existential adversary, but not Russia.
The EU views Russia as an existential adversary, but not China. So, I'm not quite sure what the role of NAITO is. Maybe it's just a paper tiger exist on paper, there's talks, but it's not a real thing. That would certainly be how you'd think about the U.N. with neither the United States nor China paying their dues to the U.N. So, it's getting underfunded.
The WTO has been totally a wall this year. The WTO hasn't been part of any conversations, which is mystifying. The IMF and the World Bank similarly seem to have disappeared. So, I think in this new world order, maybe the multilateral organizations continue to exist on paper, but I don't think they have a lot of hope.
Ingrid: You are Canadian. I mean, you live in America. You work your Canadian observations on Mark Carney and Canada and the New World Order and sort of early days of Mark Carney's term here. Yeah.
Kevin: So, stepping back a little bit from the very start of Canada, in fact, before there was a Canada, always a key issue was our relationship with the United States. And Trump is not one of the worst ten U.S. presidents from the perspective of Canada. The worst one was James Madison. In 1812, we actually invaded Canada and killed Canadians and sunk ships and stuff like that.
The second worse, which preceded him, Thomas Jefferson, who put a trade embargo on Canada, Upper and Lower Canada that time and then threatened to an annex all those areas. 1845 James Polk 5444 Fight. There's been a long list. President Nixon calling Justin Trudeau's father. Prime Minister Trudeau that time, I won't swear, but, you know, he's quite rude to our Prime Minister.
So, there's a long, long history of these difficult relationships. But what's happened the last 40 years is Canada has made an explicit politic decision, become more intertwined with the United States. 40 years ago, 68% of our exports went to the U.S. That's now ten percentage points higher at 78%. And so, it's difficult for Canada, given the natural trade flows are North-South.
Kevin: That's the way the rivers go. That's the way mountains go. It's easier for an exporter to send something to Florida than it is to send something to Manitoba, for example. So, if Canada does nothing, I think we become more integrated with the US, we become more vulnerable and we lose our identity. I'm a Canadian nationalist. I don't think that's a good thing, and to stop that, you need a host of policies.
It seems that Prime Minister Carney acknowledges this and is working with the other. The premiers in Ontario, Quebec, Alberta, B.C. and so on. On trying to lower berries into provincial trade. Like it is crazy that provinces export 20% more to the U.S. than they do to each other, so they're more intertwined with the states to the south of them than they are with other Canadian provinces.
Kevin: But I think in many different areas, Canada needs to think, what do we want to be going forward? And even, for example, Canada's tech policy, one of Canada's real strengths is and I we have lots of young people who have been taught at University of Toronto, Waterloo, UBC, McGill, and we export those young people. You've got a Silicon Valley.
It seems half the people you meet are Canadian software engineers. So maybe we shouldn't be exporting all those people. Maybe we should be trying to keep them here in the products we use. Do we want to be using products from the big U.S. tech titans? And these products do embed a lot of culture. Do we want our own culture?
I think I think Canada is that historical pivot and needs to have deep thoughts about this. And if we end up disagreeing and not coming up with a set of policies, then we will be more and more integrated with the U.S. and we will be less distinct that that's what will happen.
Ingrid: What are the most lucrative opportunities in Canada? When you look at the landscape and you touched a little bit on it.
Kevin: But yeah, so I think tech is crucial and Canada does punch way above its weight in terms of AI for the most promising AI, startups are based in Canada, three of them are based in Toronto. So, I think that's really exciting. Clearly in natural resources, oil, LNG, uranium, potash, other types of minerals, Canada has real strengths, but we need to build pipelines, we need to build ports.
And on that point, I should say one of the real opportunities for investors in here is infrastructure, because of home shoring, reshoring, the things Canada needs to do, and at the same time all the infrastructure we need for infrastructure is a fantastic asset class. I should have mentioned that earlier. In terms of services exports, only 20% of Canada's exports are services.
The numbers over 50. For the U.K., it's 35% for the U.S. So, we have lots of great firms and marketing and finance. We're mentioning IT services before. We should be much more aggressive in these areas as well. It's a long list of things that we need to be doing and policymakers need to be discussing.
Ingrid: Sort of going back on when I think is we're getting close to wrapping here messages for investors. We've been really clear on where we are in the U.S. still are. We have, i.e., it's 20% overvalued. You're optimistic about the U.S. equity markets from here in the optimistic scenario, you are optimistic for the Canadian opportunities. Who were in the world is the pain going to be felt?
Kevin: So, I think countries that are having this demand shock. So, for example, China, 3% of GDP, that's a big number. And so, we've got a 90-day period now to negotiate a deal, and we have a pretty good idea what the contours of that deal are going to look like. But it's going to be a big demand shock for China.
Kevin: And so, they were the biggest winner from hyper mobilization. They will be the biggest loser, I think. I think Germany is going to have a real challenge from this. And some countries like Japan, Korea, Taiwan, which also have big current account surpluses who depend upon exports to make up for a weak domestic demand. They have real challenges as well.
Ingrid: So, you have been in recent days and weeks touring, talking to lots of institutional investors across the country. What have I missed? What else are they asking? What else would you want to leave our listeners with?
Kevin: I think at the end of the day, so what is this meaning for investors? And I think we have to first of all acknowledge that we are in a new order. It's very different than the one most of us have experienced for a lot of our careers. At the end of 2024, the big, concentrated bets were US equities to make 7 USD.
I think going forward you definitely don't want to be long the US dollar. You still want to have tech exposure, but you want to broaden out from U.S. equities, and you also want to look at other asset classes. I think infrastructure looks especially interesting. I'm not sure there's ever been a time period when the outlook for infrastructure is better and then there's select opportunities in commodities and credit, private fixed income and in real estate.
Ingrid: It's a pretty optimistic ending. So, it feels like a good time to wrap it up. I think we've covered global realignment. We've looked at policies of home sharing, manufacturing, a little bit of George Bernard Shaw in their currency dynamics markets. I think we've really covered it all for those listeners who want to dive even deeper into some of these seismic shifts.
As I mentioned at the outset, I highly recommend checking out Kevin's recently published article, The New Global Order Implications for Investors, and we will share a link with you. So again, Kevin, thank you so much for joining me today. Thank you. And to our listeners, thank you as always for joining us on TDAM Talks.
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