Since the Brexit vote surprise, and now the clear over-reaction to it, markets seem to have gained some calm, and the S&P500 recovered more than 8% from that ugly Friday close. The risk factors that kept markets volatile during the first half of the year seem to have faded. Brexit is most likely a very slow process with negative implications mostly for the UK economy (lower investment and consumption due to uncertainty about their relationship with the continent for years to come). The Chinese currency is depreciating, but in a gradual and controlled fashion, which the markets have apparently accepted. US interest rates normalization, if any, will be gradual and sensitive to not only US economic data, but its effects on the rest of the world. Overall, monetary policy globally has been recalibrated yet again to be stimulative at the margin, or at least not withdrawing support (especially in G7).

So, is the world free of risks? Will risky asset climb higher in a sustained fashion? The answer not only depends on whether underlying economic fundamentals actually improve (productivity growth in particular), but nowadays a lot more than usual depends on politics, as we seem to possibly be at a crucial inflection point in secular trends in political terms.

The Second World War was to some extent the culmination of a secular trend towards nationalist movements that took some decades to brew. The post-war world embarked in a very long and differentiated liberalization process (first the Western Hemisphere, later the East), which accelerated with the “globalization” since the 1990s. The frustration with poor economic progress since the 2008 crisis is helping the re-emergence of nationalism and populism in the developed world. Brexit was a clear sign of such frustration expressed through a vote. More importantly, the US political process is maybe the starkest example, with the right-wing candidate proposing to cancel free-trade deals, to impose tariffs on imported goods, and restrict the flow of labor. The US is not an isolated case. France’s election next year has a similarly extreme candidate (Marine Le Pen), and Italy has the Five-Star movement that just won the city of Rome.

We do not intend to be alarmists, the world has not yet embarked in a decades long reversal of globalization. However, if this political trend materializes and becomes prevalent, this is a risk. So, what can be expected from a world that walks back globalization, that restricts the flow of goods and labor, potentially capital as well?

A general move towards protectionism would clearly reduce global growth even further, with lower incentives to invest globally due to lower trade. The efficiency of global production falls. Under the current monetary policy environment it is worth asking about inflation. Many of us have feared inflation since the monetary expansion started in 2009. Why hasn’t inflation followed aggressive monetary expansion? This is not an easy question. However, a wave of protectionism, lower trade and competition can very well accelerate the recent slight increase in inflation across many countries and regions. In such scenario, the real rate of return of capital falls, investment falls, and equity valuations should suffer. Some use the recent market reaction to Brexit to argue that if Donald Trump wins, the first sharp market move would be for a weaker dollar, as opposed to an equity selloff.

Another interesting angle of a scenario in which protectionism rises globally is to analyze winners and losers, relatively speaking as it is expected everybody loses. Mexico and China are maybe the two first casualties of a more protectionist US government. The whole Asian manufacturing block would clearly be affected. On the other side, how commodity exporters would fair in such a world is maybe a more difficult question. Protectionism emerges to reverse the loss of manufacturing jobs in G7 countries. Commodities are most likely less susceptible to suffer new higher tariffs. So, an initial assessment could be that manufacturing exporters (Mexico, Asia) suffer, while traditional emerging market countries that export mostly commodities fare relatively better. Interestingly, these commodity exporters in Latin America are also showing a different political transformation, away from populism. But those commodity producers have suffered the collapse of prices in the last few years, their currencies adjusted, and their economies continue to adjust to more economical times.

Though there seems to be an argument for commodity producers to suffer relatively less from a global protectionist trend, there is a second degree impact to consider, and that is China. If protectionism affects China adversely, and its growth rate suffers beyond the expected convergence process, demand for commodities can suffer. However, it is not difficult to argue that Chinese demand growth has fallen a few years ago, causing the commodity price adjustment seen in the last few years. The famous global rebalancing, which to a large extent centers around China’s transformation from an export-led growth model to rely relatively more on its internal consumption, is based on the arithmetic reality that China’s size is now such that global demand growth can no longer provide for its high rates of growth. In these discussions it is crucial to distinguish between flows and rates of growth. GDP is a flow, and even if there is no growth, every year the same value of goods gets produced, consumed, exported, etc. Thus, we believe there is a case to be made in which a global move to reverse some parts of globalization might affect relatively less the commodity exporters than the manufacturing bases. However, it is clear it will affect relatively more those economies that are more open in general. From a conceptual point of view, the biggest loser is the consumer in the “protected” market.

This is still an early superficial analysis, as it is too early to call for a sharp reversal in globalization. But it is clearly one of the top 3 global markets concerns that require focus and further analysis. The secularly low productivity growth phenomenon is another, and the convergence of China is maybe the third in a list of medium-term concerns.