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Globalization Under Threat: What it Means for Investors

My husband found a hole in the sole of a pair of well-loved loafers. He’s a pragmatic guy, not inclined to stuff his closet with unnecessary items and decided to bring the shoe in question to the cobbler.

He doesn’t spend quite as much time shopping online as I do, so was surprised when I suggested that it might be cheaper to order a brand new pair of shoes instead of getting that one single loafer mended.

He was aghast. Surely I was wrong.

However, one trip to the local cobbler proved me correct. Instead of the $50 fee for one fixed sole, he could buy a brand new pair of mid-range loafers for $48. With free shipping. He was already down the $.50 from the two quarters spent in the meter downtown.

I tell this story to illustrate the dramatic deflation seen in clothing and accessories over the past 10 years. The chart below from the Federal Reserve Bank of St. Louis clarifies the downward slope in the price of apparel since mid-1998 when the index hit a high of 133.

Over the next 20 years, the Consumer Price Index for urban consumers of apparel slid 6%. This deflation means the price of a sweater today is 6% less than it would have been in 1998.

I would argue that 6% is conservative. Anyone who has been to a Primark or H&M store can attest to the almost disposable price levels attached to many “fast fashion” pieces. These stores are populated with $6 t-shirts and $10 leggings.

Globalization and the Bottom Line

What created these deflationary trends? In a word, globalization.

It’s no secret that many of the clothing manufacturing jobs that used to reside in the U.S. moved offshore to places like Malaysia and China, where manufacturers could hire labor for pennies on the dollar.

I remember following many clothing retailers back in the late 1990s. Globalization was all the rage. And investors LOVED it. Ann Taylor, Coach (NYSE: TPR), The Gap (NYSE: GPS), and almost every other retailer had the same game plan, to wit: move manufacturing overseas, pay 20% less for products and lower consumer prices by a smaller amount, capturing the difference.

Atrocious fires and work conditions in overseas factories have awakened corporations and investors to the human risks of paying the lowest possible amount for labor. Many manufacturers have started to pay higher wages and they’re more vigilant about overseeing the work conditions that exist in factories that produce their goods.

However, these changes take time. Companies spent roughly 20 years fine-tuning the complex global supply chains that feed their goods into the U.S. They cultivated relationships with manufacturers in various countries, worked to overcome language and currency boundaries, and sorted air, water and ground routes for delivering goods.

The three rounds of tariffs smacked onto Chinese goods this year are throwing these well-oiled plans into chaos. The first two rounds put into effect in July and August covered $50 billion worth of products with a 25% tariff.

The third round, which hit in late September, equaled 10% but covered a much broader range of $200 billion of products. President Trump is considering one more tariff in January, this one a biggie: a 25% tariff on the remaining $270 billion of goods traded with China.

A planned meeting between Trump and Xi Jinping, the General Secretary of the Communist Party of China, at the end of November holds hope for some thawing of trade relations between the trading partners.

Tariffs: The Fuel for Inflation

More than one-third of companies reporting third-quarter earnings noted tariffs as an item impacting future estimates. Most warned that tariffs either increased the cost of products or raw materials needed for their business or that customers were delaying purchases until they found some certainty on the longevity and level of tariffs. Many companies have downgraded their earnings guidance, citing the trade war as the culprit.

These are tricky times to find strong stocks. External events like the tariffs imposed this year can blindside even the best-managed companies. One thing is for sure: the volatile stock market will behave better once companies know the outcome.

Possible new tariffs mixed with the chance of a reversal of some already implemented ones are paralyzing companies. It’s an impossible game to move forward with new suppliers or decide to stick with the older more expensive ones.

Even if the tariffs stick and companies choose to move production back to the U.S., it will be a multi-year process. Companies can’t undo a supply chain as quickly as a president can sign a tax document.

In perilous times like these, it’s best to stay cautious and get your buy list ready. Transition your portfolio away from risky momentum stocks toward high-quality value plays. Pocket partial gains on your biggest winners. And keep your powder dry for the bargains to come.

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