23rd January 2019
Should Investors be Afraid of Populism?
Chris Bailey, European Strategist, Raymond James Investment Services
“Being naked approaches being revolutionary; going barefoot is mere populism” John Updike
If you look up a definition of populism it will say something like ‘the quality of appealing to or being aimed at ordinary people’ which does not sound particularly worrisome for investors. However, when professional investors are asked about their greatest fears for 2019, ‘populism’ tends to rank highly.
With change comes uncertainty
The reason for this investor concern is centred on ‘regime change’. We are always told that change is good but it can also bring uncertainty, which can worry investors who may have made valuation judgements based on an expected future. Of course the way the financial markets onboard new ideas and ways of thinking is via price volatility, an element which has been much more apparent as 2018 progressed across most geographies and asset classes.
The return of mercantilism
If we leave aside the issue of progressively tighter controls on global immigration, there are two current main strands of populist thought that have captured the attention of the financial markets. The first I will call ‘the return of mercantilism’ and has the current President of the United States as an apparent supporter. For those unfamiliar with mercantilism, it drove much economic thought up to a couple of hundred years ago, and is centred on the concept that a country should attempt to amass wealth via exporting more than it imports when it trades with other countries and hence increasing stores of gold and precious metals (which were used at the time to underpin banking and financial systems). Now it has been many decades since the gold standard had any material role in the global financial structure, but the idea that policy shifts are required to close trade deficits, has come back to the centre of the current political debate, especially in the dusty area of trade policy. The US President’s rhetorical and actual willingness to slay some recent sacred cows of US trade policy is driven by the perceived inequalities of the current arrangements. Now, whether this is justified or not is another issue, but it raises the spectre of a return to ‘beggar-thy-neighbour’ trade policies which were disastrously last employed in the 1930s, as other important countries such as China or the economic trading blocs such as the European Union consider retaliatory measures. This is why – correctly – world trade disruption and angst is perceived as the biggest challenge for the global economy today.
Reversing the rise of inequality
Fortunately I think saner heads will prevail on this issue due to the deeply interconnected nature of the global economy and business supply chains. What may become more striking during 2019 is the second main populist thrust: ‘reversing the rise of inequality’, a nod towards recent trends which has seen the post quantitative easing influenced global economy see more proportional wealth gains accrue to those typically higher up the income/wealth spectrum who own proportionately more financial and physical assets.
If politics is a circle, classically, populism used to be perceived as existing more towards the extremities of traditional ‘left’ or ‘right’ wing views. As the John Updike quote above satirically notes, real revolutionists always regarded it as inherently lightweight. However the malaise of the political centre has led to a range of alternative parties and politicians surprisingly taking power. The current Italian coalition government which is made up of two non-mainstream political parties is one example. The unconventional political style of President Trump in America, or even the recently elected President Jair Bolsonaro in Brazil, are certainly others. However the latter two examples – so long as they do not linger on the politics of mercantilism – would generally be perceived as being broadly pro-business and therefore ultimately less likely to truly upset the applecart. By contrast, the political platforms of the Italian coalition is more interventionist and redistributory focused, reflecting the perception that the stagnation of the local economy means that change is necessary and required.
And this is what theoretically concerns financial markets: policy actions which, in short, could hinder capital and bias towards labour and typically increase the role of an interventionist government in an economy. Such a world is typically associated with lower valuation multiples (that overhang equity markets) and bigger government deficits (which impact fixed income markets) and ultimately weak national currencies, which can hinder purchasing power
So how likely is this?
The better news for financial markets in 2019 is that the market mechanism provides a safety valve in the form of lower share prices, higher bond yields and currency crises. In today’s financially interrelated world, policies that worry struggle to get the airtime to play, as we have seen in both Greece and more recently Italy. The risk – as shown in Japan and progressively in swathes of the European Union – is that malaise and inaction can result… which is no solution.
A truly politically popular approach may be a cherry picking of the best ideas from the populist strands by the current or next generation of more mainstream politicians, and blending them with their own natural instincts and policy choices. In this sense, Italy will be a fascinating political experimental zone in 2019, seeing how an instinctively populist government fuses their policy platforms with a need to remain fiscally prudent and market friendly. With current low expectations there could be surprise… and if so this would change European politics for the better. And given the last decade’s poor economic growth record, a bit of change can at least offer some different opportunities. After all, the last big regime change in the early 1980s did not work out too badly for many, did it?
With populists and unconventional parties picking up material support across many countries, electorates are clearly feeling unhappy about something tangible and the older, more traditional ways seem to need an update at least. Imitation is the sincerest form of flattery after all. So do not be too worried about the populists. Their rising popularity may just be the nudge more conventional politicians need to really step up and inspire.
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