Tectonic shifts in global supply chains

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What a move toward deglobalization could mean for investors and companies.
Before the world had even heard of the coronavirus, the intricate transnational trade networks that feed the modern factory already appeared vulnerable. A wide range of forces are responsible: From trade disputes to national security concerns to climate change and the rise of automation and robots. "It's not just one factor but many," says Candace Browning, head of BofA Global Research. "And what's remarkable is that they're all happening at the same time." The result? A fundamental — and accelerating — shift toward deglobalization, as more and more companies are bringing supply chains, manufacturing and jobs closer to home, according to a report from BofA Global Research, titled Tectonic Shifts in Global Supply Chains.
What does this mean for the U.S. and global economies? How might companies best adapt to the changing environment, and could this present new opportunities for investors? Co-authors Browning and Ethan Harris, head of Global Economics for BofA Global Research, share their thoughts on this evolving trend and the seismic changes it represents.

What ignited your sense of urgency around the changes that may be underway in the global economy?

Candace Browning: We're always looking beyond daily events at bigger economic trends affecting the United States and the world. We'd heard that companies were thinking more locally but wanted to gauge whether it was myth or reality. So, we surveyed our international team of equity analysts — who together cover some 3,000 global companies — and were struck by what we found. Across 12 industries ranging from semiconductors to capital goods, companies in more than 80% of those industries are rethinking, or plan to rethink, at least some of their supply chains. We weren't surprised that companies are shifting from China towards lower labor costs in Southeast Asia and India. What really did surprise us was the number of companies, particularly in North America and Asia, that intend to "reshore" supply chains to their own country or region. Firms in almost all industries plan to make the transition work using robots and automation. Our forecast that industrial robots will double to 5 million units by 2025 may be conservative — and the cost of automation and robots keeps going down.
Reshoring. What is it - and what might it mean for the global economy?
"Reshoring" refers to bringing a business operation that was moved overseas back to the country or region in which it was originally located. It's the inverse of "off-shoring."
What really did surprise us was the number of companies, particularly in North America and Asia, that intend to 'reshore' supply chains to their own country or region.
— Candace Browning, head of BofA Global Research

What exactly are supply chains, and why is this shift so significant?

Ethan Harris: For 60 years after World War II we witnessed a steady rise in international trade and revolutionary changes in how products are made and sold. Today, through complex networks of suppliers, a single smart phone or appliance contains parts sourced from many countries. In the last decade, though, international trade has leveled off, and our new findings suggest that what had seemed a relentless march toward globalization may now be reversing. Of course, that doesn't mean that international trade will end. But when you consider that the companies in the 12 global industries we cover represent $22 trillion in combined market value, even incremental shifts toward "deglobalization" could have major implications for economies, jobs and consumers.

Why now? What's driving this trend?

Browning: Higher wages in the developing world and advances in automation are reducing some of the cost benefits that have long made overseas suppliers so attractive. Another factor is ongoing trade tensions, even taking into account the new Phase-1 trade deal between the United States and China. National security is a growing concern as countries seek to protect their technologies. From an environmental, social and governance perspective, sourcing parts locally may leave a smaller carbon footprint and help companies ensure that suppliers treat employees well. It's too early to know which of these forces will play the most important roles in deglobalization, but we'll be watching developments closely.

Who might the beneficiaries be, and where are the challenges?

Harris: U.S. companies seem most ready to embrace automation and its cost savings. Technology companies and their suppliers could benefit as demand for robots rises. Generally, larger companies tend to have multiple suppliers and their scale may give them greater flexibility to adjust supply chains. China faces perhaps the greatest challenges. The underlying story is positive, with a rising middle class earning more money. But that means China needs to speed up its effort to depend less on exports and more on domestic consumers and services. The coronavirus, which has forced a number of Chinese factories to slow down or stop production altogether, contributes to these pressures.
We're calling this a 'tectonic' shift because we expect things to move slowly but persistently over the next five or 10 years. It won't happen overnight, but some of the forces seem unstoppable.
— Ethan Harris, head of Global Economics,
BofA Global Research
Browning: Small U.S. businesses may also benefit as part of industrial "clusters" that develop when large manufacturers move into an area. Manufacturers spend 5.5% of domestic net sales on research and development, compared with 3.6% for non-manufacturers, so that, too, creates opportunities for companies that support them.Footnote 1 In some cases, reshoring will mean moving supply chains to nearby developing countries. So Mexico is likely to benefit from re-shoring of U.S. companies, for example.

What does all this mean for workers and consumers now?

Browning: Some 400,000 U.S. factory jobs are currently unfilled, and companies are going out of their way to lure job seekers with higher wages, signing bonuses and other benefits. Moving supply chains closer to home will increase the demand for skilled workers such as welders, engineers and machine programmers — and manufacturing jobs already pay 15% more in total compensation than nonmanufacturing jobs.Footnote 2 So, wages are likely to grow. But jobs, too. Ten years ago, conventional wisdom held that workers were all going to be replaced by robots. Yet while automated factories do require fewer employees, every new manufacturing job generates an estimated six additional jobs indirectly.
Manufacturing has a multiplier effect
The add-on effects when manufacturing returns home can support additional economic development in many areas.
Reshoring and relocating manufacturing back home can lead to skilled jobs, higher wages, an improved tax base, industrial clusters; and drive R&D.
Source: BofA Global Research
The benefits may be less pronounced among service companies, and unskilled workers will face steeper challenges. So, companies and policymakers alike will have to emphasize retraining and other programs to help give workers the skills they need for the new manufacturing landscape.
Harris: For consumers, a lot depends on what the major forces behind deglobalization turn out to be. If it's mostly about trade barriers, consumers will pay higher prices, which is obviously not good for them. But if it's because companies find greater efficiency through automation and lower shipping costs, that's good news for everyone. That story is still unfolding.

What risks does deglobalization present?

Harris: Protectionism or national security could prompt government anti-trade policies that make this process happen much too quickly. In the technology sector, for example, different countries have developed very different capabilities. Forcing everyone to suddenly shift to local supply chains would be incredibly expensive and quite disruptive. One of the toughest challenges for governments will be finding ways to address national security concerns while minimizing those disruptions.

How quickly do you expect these changes to take place — and what should investors watch for?

Harris: We're calling this a "tectonic" shift because we expect things to move slowly but persistently over the next five or 10 years. It won't happen overnight, but some of the forces seem unstoppable. National security and protectionist concerns aren't going away. Automation's not going away. Labor costs in China aren't going to suddenly drop.
Browning: While deglobalization is likely to play out over a number of years, a look at market values and fund investments tells us that investors may not be fully prepared for a sustained recovery in manufacturing that could begin by mid-2020. We see opportunities ahead for industries ranging from automation to industrials to the banks that will help finance changes in supply chains. For these reasons, we believe investors should start thinking now about the implications for their portfolios, and how they can prepare for the global shift.

What could deglobalization mean for your portfolio?

As companies in the U.S. and around the world move production closer to home, implications for the global economy are huge, says Marci McGregor, senior investment strategist with the Chief Investment Office, Merrill and Bank of America Private Bank. Yet when it comes to your own financial future, world trends get personal in a hurry. Here, McGregor shares some thoughts on how to prepare for a coming age of deglobalization.

Don't overreact to volatility

"Deglobalization isn't a story for 2020, it's a story for the 2020s," McGregor says. "Though we may experience periodic corrections or even recessions along the way, this trend and the innovations it represents strengthen the view of a long-term bull market." Preparing for deglobalization doesn't call for sudden, sweeping changes in your portfolio, she notes. Rather, it's about recognizing investment opportunities and being prepared to stay invested through periods of volatility as the economy adjusts. "Anytime there is a major transition like this — even if it's a slow-moving one — you can expect a period of initial disruption. That's one reason why we always advocate for our clients to take a long-term view towards investing."

Look to stocks for growth

"We believe we're in an extended bull market for stocks," McGregor says. "Innovation will be a hallmark of this global-to-local trend. Supply chains will be smarter and more efficient when they move." Thus, investors may find strong opportunities in sectors such as technology, particularly companies involved in automation and robotics. Industrial stocks hold promise as well, as do banks, which will be needed to help finance the new supply chains as companies de-globalize. "That said, there's certainly a place for bonds to help you manage risk," McGregor says.

Continue Investing Globally

Even as companies and supply chains become more local, investors should continue to diversify portfolios overseas, McGregor notes. "Deglobalization is just one of several important themes at work in the world today," she says. Another is rising wealth, especially in developing markets. "By the end of this decade, 80% of the world's middle class will be living outside the United States and the E.U.Footnote 3 These markets are not to be ignored." In particular, as supply chains shift away from China, investors may find opportunities in North America, India and Southeast Asia.

Keep it personal

As you think about broad changes in the economy, keep in mind that any investing decisions start with a thorough understanding of your personal goals. "One of the biggest decisions is how much risk you're willing to tolerate in your portfolio," McGregor says. "That's going to be your roadmap as to which investments you select to take advantage of deglobalization and other emerging trends. Then, working with your advisor, you can begin to consider which industries, countries and regions might provide the best opportunities."
Next steps

Footnote 1 National Science Foundation, National Center for Science and Engineering Statistics, 2016.

Footnote 2 Economic Policy Institute (Adapted from Langdon and Lehrman, 2012).

Footnote 3 Roland Berger, 2013

Information is as of 03/16/2020.

The views and opinions expressed are those of the authors and are subject to change without notice.

It is presented for informational purposes only and should not be used or construed as a recommendation of any service, security, or sector.

Investing involves risk, including the possible loss of principal. Past performance is no guarantee of future results.

Asset allocation, diversification, and rebalancing do not ensure a profit or protect against loss in declining markets.
Equity securities are subject to stock market fluctuations that occur in response to economic and business developments.

Investments in foreign securities involve special risks, including foreign currency risk and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are magnified for investments made in emerging markets.

Bonds are subject to interest rate, inflation and credit risks.

Investments in a certain industry or sector may pose additional risk due to lack of diversification and sector concentration.

BofA Global Research is research produced by BofA Securities, Inc. ("BofAS") and/or one or more of its affiliates. BofAS is a registered broker-dealer, Member SIPC popup, and wholly owned subsidiary of Bank of America Corporation.
The Chief Investment Office (CIO) provides thought leadership on wealth management, investment strategy and global markets; portfolio management solutions; due diligence; and solutions oversight and data analytics. CIO viewpoints are developed for Bank of America Private Bank, a division of Bank of America, N.A., ("Bank of America") and Merrill Lynch, Pierce, Fenner & Smith Incorporated ("MLPF&S" or "Merrill"), a registered broker-dealer, registered investment adviser and a wholly owned subsidiary of Bank of America Corporation ("BofA Corp.").