Gloomy and More Uncertain. That was the title of one of the International Monetary Fund’s updates this year for the World Economic Outlook, as it took stock of the macroeconomic and geopolitical environment.

Economic growth, up until the last decade, happened without acknowledgement of environmental and social costs, better known as the externalities of doing business. As countries across the globe recognize the challenge of climate change, there is a growing recognition that putting a price on pollution or green house gas emissions is both important and necessary. 

The digital revolution is transforming industries and shuffling the ranks of firm leaders and laggards, as market power shifts to companies that can adapt their business models and take advantage of emerging technologies. At TDAM, we believe a disciplined fundamental active investment strategy can add alpha by identifying these shifts before they are fully reflected in companies’ stock prices.

Global supply chains are being overhauled to reduce vulnerabilities and to restrict Chinese imports of “dual-use” products that can be used for both commercial and military purposes. In Part I of this two part series we show why the initial focus is on semiconductors and energy, and where it might go from there (AI, quantum computing, and other advanced tech). We also demonstrate the challenges for Chinese equities and U.S.-based multinational corporations, which have been the two biggest beneficiaries of globalization.

In this second part of our two-part series, we demonstrate that deglobalization implies trend increases in capex and the labor share, as well as a higher weighted average cost of capital (WACC). This constitutes a secular headwind for margins and free cash flow (FCF), especially for tech and manufacturing. With companies facing greater macro volatility and an elevated WACC, we expect lower average multiples. This will prove especially challenging for longer duration assets, such as venture capital and speculative tech companies that are years away from generating FCF on a sustainable basis.

We look at the importance of understanding how company management is compensated when analyzing a stock, particularly as it relates to the Quality Capital Reinvestment Strategies.