Shrewd investors assess history’s threat to globalisation

Last updated: March 28, 2014 4:39 pm

Shrewd investors assess history’s threat to globalisation

By John Authers

History, it appears, has restarted. Back in 1990, after the Berlin Wall fell, Francis Fukuyama famously prognosticated that we were witnessing not just the end of the cold war but “the end of history as such”. Our ideological evolution, he said, was complete, with the universalisation of western liberal democracy as “the final form of human government”.

Now it looks premature to have declared the cold war over, let alone history itself. Dialogue between Washington and Moscow these past few weeks is painfully reminiscent of an era many thought had ended some 30 years ago.

Very much more history may lie ahead of us. The parallels between events in Crimea and the first links in the chain of mistakes 100 years ago that led from an assassination in Sarajevo to all-out world war are obvious, even without the current welter of historical retrospectives.

But history has not suddenly restarted in the past few weeks. Rather, concern has grown for some years that our “ideological evolution” is far from complete, and that ideologies very different from western liberal democracy continue to hold sway. That is what the markets have said.

The investor mood towards emerging markets soured some three years ago, and has continued to worsen. There are many drivers for this, but one of them tends to be omitted. That is that investors are alarmed at the deviations from western capitalism that are afoot.

John-Paul Smith, head of emerging markets research at Deutsche Bank, has divided the stocks in the MSCI emerging markets index into those that are state controlled, and those that are not. Since September 2011, the non-state stocks have almost held their value, dropping only 2 per cent. State-controlled stocks fell 12 per cent.

Further, countries with the most large companies under state control have fallen more. These include China (where the state runs 78 per cent of the largest quoted companies), Brazil (30 per cent) and Russia (55 per cent).

Investor disquiet goes far further than Russia. Look at Turkey, reversing basic western attitudes to freedom of speech by shutting down Twitter and YouTube. Or Brazil, run for more than a decade by leftwing governments.

In Brazil, state-controlled companies sell for 10 per cent less than book value; others sell for three times book. A corollary of the unpopularity of state-owned enterprises is that foreign money pours into whatever else it can find – leading to extreme valuations. In Russia, some retailers, not owned by the state, sell for nine times book value.

There are, particularly since the 2008 crisis, ample reasons for emerging electorates to turn their back on the western model. Russians are disgusted with the way their crown jewels were privatised in the 1990s, and created a generation of oligarchs.

Even Mexico, in favour with investors, suffers deep resentment at botched privatisations of the 1980s and 1990s. The state oil company remains closed to foreign investors.

Emerging governments also point out that their public finances are far healthier than those of the west. Indebtedness in emerging countries rose only briefly after the crisis. The west was different.

But emerging markets investors still have thorny issues. Treating all emerging markets as one asset class makes little sense. And the vaunted cheapness of emerging markets as a whole turns out on closer examination to rest on the deep unpopularity, and hence cheapness, of state-controlled sectors such as Chinese financials. Other sectors look if anything overpriced.

Is a slide back to two ideologies and an end to globalisation inevitable? No. Marcus Svedberg of East Capital, which invests in Russia, suggests that “Russia is too rich to tolerate bad corporate governance for much longer”. With middle classes across the emerging world enriched and empowered, a Fukuyama-esque dynamic towards shareholder-led capitalism should be hard to thwart.

But it cannot be taken as a given, as many investors had done during the era when history appeared to have ended.

This has implications for developed world stock markets, which briefly exceeded their pre-crisis high last month, before stalling. The bull market of the 1990s can be seen as a reaction to the “peace dividend” that came with the fall of the wall. That dividend was overstated, and markets overshot.

Now, investors must ask whether they must repay some of the peace dividend that they did receive. The sanctions proposed for Russia imply a rollback of globalisation, in a way that hurts everyone.

There are of course potential justifications for such sanctions. That is a separate debate.

Assessing political risk is difficult for markets. They are bad at it, and may have overreacted in the emerging world. But the need now is to question assumptions about the triumph of globalisation and capitalism. Investors in emerging markets have already begun to do so.