When History Repeats Itself: The Next Industrial Revolution

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In the early 2000’s, Americans had come accustom to paying $400 for a desktop computer, and had little foresight that they were assisting in the fall of the US Economy.  With higher disposable incomes, in a consumer driven economy, consumers, retailers and financial organizations found themselves over-leveraged, creating a perfect storm scenario.  With the recession now in the rear-view mirror, investors find themselves experiencing pre-recessionary déjà vu.  Not only are investors coming off of the sidelines and playing catch-up with risky investments, more firms are streamlining operations looking to replace costly human capital.  This month’s edition of The Samra Report focuses on off-shoring and outsourcing, technology replacing human capital, and how to prepare your portfolio against the next market shock.

During then Presidential candidate Donald Trump’s campaign trail, the presidential nominee promised to bring back coal mining jobs at an Iowa rally.  From an economic viewpoint, mining and manufacturing jobs will not be returning to the United States as promised.  There are two parts to this conundrum:

  1. China is the world’s largest consumer of coal.  China is also the world’s largest producer of coal, flooding the market with over four times the amount of coal as the United States.  The United States cannot sustain a supply to match the world price of coal, given two major factors: the cost of domestic labor, and the cost of shipping coal to Asia.  
  2. The United States has seen a decline in manufacturing’s share of employment since the late 1940’s.  Part of this decline is due to a growing service sector and increased automation, however, more recently manufacturing jobs have been (1) Off-shored; (2) Outsourced; (3) A combination of outsourced and off-shored: why 3D print materials here in the United States, when they can be printed at a steep discount in China.  Domestic manufacturers face a disadvantage with the minimum cost of labor.  It is important to note that domestic jobs are not necessarily being outsourced because of the pulling effect from countries like India and China, however, companies like Walmart and Amazon are able to push prices down eliminating domestic competition. 
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As more companies increase investment spending into automation, robotics, drone technology and Blockchain.  There will come a time when dependence on human capital declines, leading to lower wage levels.  In a consumer driven economy, this will inevitably lead to lower retail sales, higher unemployment and economic indicators pointing towards a recession.  Although it is likely the majority of investors will sustain losses, this time like any other will also create opportunity.  At Samra Wealth Management, our thoughts are aligned with that of the World Economic Forum, We are on the cusp of a global industrial revolution. “The McKinsey Global Institute frames the Fourth Industrial Revolution as the age of “cyber-physical systems”—systems that integrate computation, networking and physical processes. These include a myriad of technologies that span themes such as mobile devices, the Internet of Things, artificial intelligence (AI), robotics, cybersecurity and 3D printing. This revolution will bring benefits and challenges for businesses.”  The three industrial revolutions prior caused the extinction of many outdated trades and businesses unable to adapt.  This revoltution will be no different, as the World Economic Forum estimates five million jobs will be lost.  However, unlike the past where tradesmen were able to move into other unskilled fields, the fourth industrial revolution will require workers to develop advanced skills, skills such as computer coding and engineering focused on autonmous vehicles.  Over the past year, restaurants in metropolitan areas have replaced wait staff with iPads.  Cafe X in San Francisco has gone as far as introducing robots into their coffee shop.  At Samra Wealth Management, we expect the global phenomenon to be more drastic.  Businesses implementing technology will leap frog first and second generation systems, just as it has done with smart phones, increasing internet penetration in the most rural of areas, further increasing marketshare, opportunity and global competition.

As domestic markets reach new daily highs, the financial media will continue with its “perpetually pessimistic and often wrong” outlook.  Although the majority of economists and financial analysts agree that 2018 will be a good year for the US economy, and for the market, it is important for investors to remember their portfolio’s should be prepared for market shocks and downturns. At Samra Wealth Management, it is our belief there are 3 methods to help dampen portfolio volatility:

  1. Global Stock Markets and Currency Risk: Although we favor the United States, all investors should have some allocation of their portfolio invested outside of the United States.  Investors should not blindly invest in developed or emerging markets without taking into consideration when to hedge currency risk.  With a third rate hike expected later this month, it is likely the greenback would strengthen, eroding returns from abroad.  Surprisingly, wealth management firms like Merrill Lynch provide investors with some of the best research available.  However, there remains a clear disconnect between the research and portfolio construction and management.  For example, over the last year, Merrill Lynch has provided research with a high conviction for 3 interest rate hikes during 2017.  On a fundamental level, when interest rates in a domestic economy increase, this leads to increased foreign investors investing in the domestic market, further strengthening the domestic currency.  Although this may seem confusing to novice investors, the year to date difference between investing in Japan versus investing in Japan with a currency hedged strategy would have yielded a 1.5% difference, with the expectations of a greater spread if the Federal Reserve hikes interest rates in December as many economists expect. 

2. Alternative Investments (AI): Investments other than traditional (Cash, Stock, and Bonds), typically consisting of allocations towards real estate, hedge funds, private equity, commodities, and more recently cryptocurrency.  As these investments have little to no correlation with stocks and bonds.  Modern portfolio theory states investors can optimize returns, lowering volatility by allocating a portion of their portfolios towards alternative investments. 

3. Convertible bonds & structured notes: Although most investors are familiar with conventional fixed-income investment vehicles, convertible bonds and structured notes present more confusion.  “A convertible bond is a type of debt security that can be converted into a predetermined amount of the underlying company's equity at certain times during the bond's life, usually at the discretion of the bondholder.”  Convertibles offer a set maturity and coupon, like conventional bonds, however, allow the investor to share in the gains of the underlying stock.  During times of uncertainty, convertibles can help provide a modest return, and in today’s economy, the Global Convertible Bond Index (G300) up 13.28% through September 2017.  “A structured note is a debt obligation that also contains an embedded derivative component that adjust the security's risk/return profile.  The return performance of a structured note will track both that of the underlying debt obligation and the derivative embedded within it.  This type of note is a hybrid security that attempts to change its profile by including additional modifying structures, therefore increasing the bond's potential returns.”  Structured notes can provide the investor with exposure to commodities and foreign markets, previously unaccessible to them.  

Preparing for a market shock, or downturn requires investors to invest in assets that may generate lower returns, however, the goal is to dampen volatility, and provide peace of mind.  With all of the PhD’s and CFA’s employed by the largest investment companies, no one saw the near collapse of the financial markets less than a decade ago.  For this reason, at Samra Wealth Management, we recommend strategies to help hedge downside volatility to all of our clients. 

 

 

 

 

 

 

All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed.  All economic and performance data is historical and not indicative of future results.  All views/opinions expressed herein are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC. The information and material contained herein is of a general nature and is intended for educational purposes only.  This does not constitute a recommendation or a solicitation or offer of the purchase or sale of securities. Before investing or using any strategy, individuals should consult with their tax, legal, or financial advisor.

While structured notes may enable individual retail investors to participate in investment strategies that are not typically offered to them, these products can be very complex and have significant investment risks.  Before investing in structured notes, you should understand how the notes work and carefully consider their risks.

 

References

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Bloomberg.com. (2017). DEWJ Quote - iShares Adaptive Currency Hedged MSCI Japan ETF Fund. [online] Available at: https://www.bloomberg.com/quote/DEWJ:US [Accessed 1 Dec. 2017].

Futurism. (2017). Things to Come: A Timeline of Future Technology [INFOGRAPHIC]. [online] Available at: https://futurism.com/images/things-to-come-a-timeline-of-future-technology-infographic/ [Accessed 26 Nov. 2017].

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Mannes, J. (2017). Cafe X opens in San Francisco, bringing robots to the coffee shop. [online] TechCrunch. Available at: https://techcrunch.com/2017/01/30/cafe-x-opens-in-san-francisco-bringing-robots-to-the-coffee-shop/ [Accessed 28 Nov. 2017].

Samra, I. (2017). Divesting vs. Reallocating Exposure. [online] SAMRA WEALTH MANAGEMENT. Available at: http://www.samrawealthmanagement.com/market-commentary/2017/6/5/divesting-vs-reallocating-exposure [Accessed 1 Dec. 2017].

Staff, I. (2017). Structured Note. [online] Investopedia. Available at: https://www.investopedia.com/terms/s/structurednote.asp#ixzz501mU2gxL [Accessed 30 Nov. 2017].

Stlouisfed.org. (2017). Is U.S. Manufacturing Really Declining?. [online] Available at: https://www.stlouisfed.org/on-the-economy/2017/april/us-manufacturing-really-declining [Accessed 29 Nov. 2017].

Wellesley Asset Management (2017). What Keeps Me Up at Night. Wellesley Asset Management, pp.1-5.

Youngworth, CFA, M. (2017). Global Convertible Chartbook: Think Small. October 2017. Bank of America, Merrill Lynch, pp.1-12.