Electorial victories by populist movements in Europe would have serious implications for institutional investors, warn Gijsbert de Lange and Cees Harm van den Berg
At a glance
•The digital revolution, by widening inequality, has given impetus to the rise of populism.
•Populist parties are associated with nationalism and protectionism.
•A strong populist performance is possible in upcoming elections in France, Germany and the Netherlands.
•Populist wins in the euro-zone are likely to lead to reduced stock market returns, higher interest rates and a weaker euro.
The Brexit vote in the UK on 23 June again demonstrated the strong momentum behind anti-globalist populism in the EU. To understand the possible economic consequences and market impact of populist wins in upcoming elections and referendums in the EU, one must understand the background of this renewed anti-globalisation.
The third industrial revolution (1970 to date), also known as the digital revolution, marks the change from mechanical/analogue technology to digital electronics. During this period, as before during the first (1760-1840) and second (1870-1913) industrial revolutions, we have seen increased global trade, sustained economic growth and rising living standards, but also an increase in unemployment and income inequality. Over the past decade, 20-25% of households in rich countries have seen incomes stay flat or decrease. Many low to mid-skilled, blue-collar workers in uncompetitive industries have lost their jobs, owing to digitalisation and globalisation. Anti-globalist populist parties with their nationalist policies have consequently seen their appeal increase.
Election victories of populist parties may lead to nationalist policies, protectionism, and protection of employment in uncompetitive industries.
A particular characteristic of the current period, one not shared with previous industrial revolutions, is the ageing population. In the EU, the proportion of over 65s has reached 19%, with Germany and Italy, at 21%, having the most aged societies (compare France and the UK at 18%). At the same time, the old-age support ratio, the number of workers aged 20-64 relative to those aged over 65, will roughly halve from current levels of about 3.0 to 1.5. Only immigration could make up for the fall in the numbers of workers. As the baby boom generation, associated by many with privilege, has started to move into retirement, their political beliefs have moved towards the closed societies espoused by populist parties, as illustrated by the age distribution of Brexit leave voters.
The digital revolution has increased the speed with which information about trading and investment opportunities travel across countries and continents. Optimising global supply chains became of huge importance in the corporate decision-making process, limiting the influence of national economic policies. Trade liberalisation (lower tariffs) and the emergence of newly industrialising countries (emerging markets) as well as global real-time information sharing via the internet (from the 1990s) accelerated the globalisation processes we have experienced in the last 20 years.
Contrary to the belief in the 1990s, the fruits of globalisation have not been not shared equally. Beneficiaries in the global economy tended to cluster around centres with access to superior infrastructure and knowledge pools. In developed countries, competition from new global manufacturing centres contributed to a ‘hollowing out of the middle’, as workers unable to upgrade their skills lost employment or suffered real-income declines.
Member countries of the EU were affected to different degrees by the globalisation pressures and by the global financial crisis of 2008-09, which has led to tensions in policy coordination, particularly within the euro-zone. Increased migration (within the EU and from outside) has exacerbated this, giving momentum to populist movements that promise to reverse ‘unfair’ globalisation.
Traditionally, the view from Germany has been to redress deficit imbalances by way of austerity and structural reforms and this view has hitherto prevailed as the consensus in the euro-zone. However, election victories of populist parties in deficit countries would put the likelihood of austerity continuing under pressure.
Three countries have already experienced election or referendum victories by populists: Hungary, Poland and the UK. Hungary and Poland are implementing remarkably consistent economic policies that include:
• Increased spending on subsidies that benefit the generally lower earning populist electorate;
• Taxing of economic sectors with high foreign ownership and of higher earners;
• Pension fund nationalisations;
• Weakening of independent public institutions.
These measures, if adopted across more EU countries, would bring the end of austerity and structural reforms and a possible increase in deficits. They would also lead to protectionism, with import duties and taxation of foreign ownership, possible sovereign debt downgrades by rating agencies and weakening of European Central Banks (ECB) independence. The weakening of ECB independence might result in further quantitative easing and monetary financing.
Elections are scheduled across many EU countries over the next two years, most notably in the large economies Italy, Netherlands, France and Germany. The possibility of populist victories appears relatively large in Italy and the Netherlands and relatively small in France and Germany. Recent polls point to the possibility of populist victories particularly this month in Italy and in March next year in the Netherlands. In the Netherlands the right-wing nationalist PVV has been neck and neck with the ruling Conservative VVD in the polls for a year now, but in case of an electoral victory may struggle to form a coalition government. In Italy’s constitutional referendum a ‘no’ vote could lead to the government resigning and possibly to new parliamentary elections. The anti-globalist and eurosceptic Five Star Movement would probably win an election by a narrow margin, according to recent polls.
Populist victories or strong results in Italy or the Netherlands will have an indirect impact too, as governments in other EU countries will be influenced by their populist political agenda and adopt parts of it. In our view, political developments in the near future in Italy are therefore key to those elsewhere in Europe.
The implications for institutional investors from populist wins are ample but, in general, reduced stock market returns, sector-related differences, increasing interest rates and a weaker euro are all likely outcomes.
• Reduced stock market returns. Reduced profitability of companies’ earnings owing to decreasing economic growth will lead to reduced stock market returns. Greater uncertainty with regards to economic policies would lead to heightened volatility of share prices. Institutional investors can reduce their exposure to lower stock market returns by either increasing diversity in their portfolio using alternative asset classes, or by implementing a downside protection strategy appropriate for the investment target, or both.
• Underperformance of trade-related industries. Companies involved in global trade will underperform companies that predominantly sell goods and services domestically or within the EU. Tariff increase and trade barriers will reduce profitability of companies relying on global trade.
• Higher interest rates. Larger deficits should, in theory, lead to steeper yield curves and increased rates due to inflationary pressures. An increase in quantitative easing after populist wins would offset this, at least partly. For institutional investors, it is important to reduce exposures to risks that do not provide a positive premium. Interest rate risk is an example of a risk without a positive premium and should therefore be hedged.
• Weaker euro. Larger deficits, reduced economic growth/profitability and accommodative central bank policies lead to decreasing currency values. For institutional investors with euro-denominated liabilities and hedged foreign investments, this may lead to potentially large losses on foreign exchange overlays, compensated by an increase in value of foreign investments. Developed markets currency risk is another example of a risk without a positive premium and should therefore be hedged.
The growing electoral profile of anti-globalist populism is likely to hit economies in Europe and beyond. Institutional investors should not only be aware of these developments but also be prepared to act to withstand the associated risks.
Gijsbert de Lange and Cees Harm van den Berg are investment consultants at Willis Towers Watson
Outlook 2017: Will the great unravelling continue?
- Currently reading
Outlook 2017: The rise of populism