Protectionism Is on the Rise and Coming to a Stock Near You

Trade wars threaten everybody's prosperity, and companies like FedEx and Dry Ships are obvious victims. In addition, global leaders like Cisco and Pfizer could also find growth harder to come by if protectionist measures increase.

Jan 10, 2014 at 4:34PM

Since the recession of 2008 the main debating point of the investment community has been over the possibility of a sustainable recovery in the global economy. However, this focus could lead many investors to be blindsided by the fact that increased protectionism has caused world trade to grow slower than global GDP. The repercussions have been directly seen in transportation plays like shipping company DryShips (NASDAQ:DRYS) and FedEx (NYSE:FDX). Moreover, an increased climate of protectionism, led by countries such as India, also threatens prospects for companies as diverse as Cisco (NASDAQ:CSCO) and Pfizer (NYSE:PFE).

Global trade growing slower than GDP
Over the last few months, three highly regarded institutions have highlighted the increasing growth of protectionism in the global economy. First, in an interview with CNBC television, World Trade Organization Director-General Roberto Azevedo outlined that the WTO would downgrade world trade growth estimates for 2013 from 3% to 2.5%. In addition, 2014 estimates would be cut from 5% to 4.5%. These would be done because of protectionism.

Second, the EU produced a report that highlighted a "worrying increase in the adoption of certain highly trade-disruptive measures." Interestingly, the emerging markets appear to be the worst culprits with Brazil, Argentina, and India cited in the report's conclusions.

Third, the International Air Transport Association argued that almost 500 protectionist measures were taken in 2012 alone.   Furthermore, data from the IATA clearly demonstrates that airplanes' cargo revenue and passenger revenue have diverged since the recovery took place. Cargo revenue is particularly susceptible to protectionism.

Trade

Source: IATA.

Transportation companies FedEx and DryShips affected
The immediate consequences can be seen in air cargo and transportation companies. For example, FedEx has undergone a remarkable transformation in profitability in recent years.

Fedex
Source: Company presentations.

In recent years, FedEx has had to retire planes in its express segment because international express and cargo revenues have been less than hoped for.   The company still has good long-term growth prospects from e-commerce demand and its internal productivity improvement program. However, if a trade war escalates, then FedEx is likely to be a loser.

Moreover, the impact isn't restricted to air cargo. Shipping has also struggled, and a historically accurate predictor of the global economy, the Baltic dry index, has diminished in importance. The index is a measure of the shipping costs of moving raw materials. For example, here is a chart of the share price of Dry Ships vs. the Baltic dry index.

DRYS Chart

DRYS data by YCharts

Spot the correlation!

Shipping companies will be inordinately hit by a trade war, because they rely on future cash flows to at least offset the depreciation in the value of their shipping fleet.

Technology, pharmaceuticals, and consumer goods
A full-on trade war will obviously hurt the global economy, so most companies will be affected. However, smaller protectionist measures will hurt some companies more than others.

The U.S. is a major exporter of technology solutions, and Cisco is one of its leading players. Cisco just reported a very weak quarter for its emerging markets, and it's not clear if it was at least partly due to protectionist measures.

It would not be surprising if tit-for-tat measures were being taken by certain governments. In 2012, a U.S. House of Representatives report argued that Cisco's Chinese rivals Huawei and ZTE "could undermine core U.S. national-security interests," and went on to recommend that Huawei and ZTE be excluded for government work. While the U.S. may be completely justified in its actions, the potential repercussions should be considered by tech investors hoping for emerging market growth.

The pharmaceutical industry is another area of huge concern. Last year, Pfizer's chief intellectual property counsel, Roy Waldron, delivered a damning congressional testimony on the "rapid deterioration of the business environment in India." Waldron argued that India "demonstrates a flagrant disregard of patent rights." The revoking (twice) of its patents for cancer drug Sutent (while an Indian generic manufacturer launched its product on the market), and the denial of a patent to Pfizer's anticancer therapy Gleevec, were of particular concern. India stands accused of discriminating against U.S. companies in favor of supporting its own generic manufacturers, while its companies benefit from open markets in the U.S.

The bottom line
The rise in protectionism is a worrying trend in the global economy because everybody will suffer if it escalates. However, some industries will suffer more than most and long-term investors in the types of companies discussed above will need to keep an eye out for developments. In particular, countries such as India need focus more on halting their own creeping protectionism, rather than pointing fingers at others.

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Lee Samaha owns shares of Cisco Systems. The Motley Fool recommends Cisco Systems and FedEx. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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