Populism was one of the biggest market influences in 2016, with Brexit and Donald Trump’s election front and center. As we’ve talked about for several years now, populism is a macro theme that affects a number of countries, with broad market and currency implications.
With significant victories such as Trump’s, other would-be populist leaders become emboldened, increasing the likelihood of populist-inspired leadership and policy changes elsewhere. And investors need to begin to factor such changes into their decisions.
Emboldened would-be populist leaders increase the likelihood of populist-inspired leadership and policy changes elsewhere. And investors need to begin to factor such changes into their decisions.
Consider another event in the fourth quarter of 2016: a constitutional referendum in Italy brought by former Prime Minister Matteo Renzi. Although this was not a populist issue, per se, Renzi had committed to resign if his proposal was not approved. The result can be viewed as an “anti-establishment” vote, partly because of Renzi’s resignation promise, and because it was an emphatic rejection by a wider margin than polling organizations predicted.
In 2017, the focus of populism as a theme remains in Europe, with a presidential election in France in the first half of the year and Germany’s federal election in the second half. In France, the anti-euro party (National Front) led by Marine Le Pen is expected to pose a strong challenge. In Germany, Chancellor Angela Merkel has signaled her intent to run for a fourth term. Merkel retains high levels of support, but this has been recently reduced because of her liberal stance on immigration, which has aroused increased opposition. Merkel also represents the status quo (the opposite of populism) to a marked extent, having been in office since 2005.
Votes where populist sentiment prevails tend to carry elements of both geopolitical risk (uncertainty wrought from a successful challenge to the status quo) and macro-thematic risk (the likelihood of less globalization-friendly policy changes).
How do we manage these risks in our portfolios? As one example, before the U.S. election, we introduced downside protection to U.S. equity and U.S. fixed income (in the latter case reducing exposure to potentially higher bond yields). We also added downside protection on broad emerging market equities due to the potential negative sentiment of a Trump win with respect to his potential anti-trade policies. In currency, we specifically reduced our long exposure to the fundamentally attractive Mexican peso as the potential anti-trade policies from a Trump administration could particularly affect Mexico, given campaign trail overtures that Trump would take the United States out of the North American Free Trade Agreement (NAFTA).
After Trump’s victory, which came along with a Republican majority in both legislative houses, we began anticipating less significant change in the direction of trade opposition, and comparatively more policy change in the direction of boosting growth (and growth expectations) via tax reductions and regulatory changes. Consequently, we moved back into the Mexican peso, which had cheapened, and increased exposure to emerging market equities.
Populism-inspired geopolitical and macro-thematic risks arising from the aforementioned events will thus still have to be navigated going forward, as will the negotiations between the United Kingdom and the European Union on Brexit once Article 50 is invoked, likely later this month.