What Populism Means for Your Portfolio

New Leadership Challenges the Status Quo

Photography by ZhangXun / Getty Images.

Britain’s decision to leave the European Union and Donald Trump’s election as President of the United States have marked the beginning of a new era of populism in the developed world. Some international investors may be quick to dismiss these events given the S&P 500 and FTSE 100’s recent strong performance, but populist cycles often last over a decade and the resulting policies could threaten the economic prosperity brought by globalism.

Let's take a look at what the rise in populism means for your portfolio and how to hedge against some of the risks.

What’s Behind the Trend?

There are many factors that have led to the rise in populism around the world. Populist measures may not be the solution to these problems, but it’s important for investors to understand the root cause of these trends, since they could help predict policy action. For example, a response to income inequality may be raising capital gains taxes that affect the wealthy, which could have a significant impact on capital flows from investment.

Some of the key factors behind the trend include:

  • Slowing Growth. Gross domestic product (GDP) growth has fallen from 6 percent in the 1960s to 3 percent in 2015 following the 2008/2009 global financial crisis.
  • Income Inequality. The annual share of income among the top 1 percent rose from 10 percent in 1980 to 23.5 percent by 2007, while wage growth has been slow across the world.
  • Immigration. Refugees have become a concern in Europe where they have been blamed for terrorist activity, while U.S. job loss and hardship has been blamed on immigrants.
  • Technology. Technology has created many high-skill jobs, but has replaced more low-skill jobs through automation and obsolescence.
  • Globalization. Globalization has, like technology, resulted in many low-skill jobs being outsourced to cheaper labor pools, creating discontent in domestic markets.

Populism Around the World

There are many instances of populism on the rise around the world, including in the United States and Britain. By tracking these events, investors can understand when market moving events may occur and make decisions to hedge or adjust their portfolios.

The ‘Brexit’ marked the first major populist victory in Europe as British voters opted to leave the European Union. The success of the ‘Brexit’ campaign sparked several other anti-establishment groups throughout the E.U., including Italy’s Five Star Movement, Germany’s Alternatives for Germany, and France’s Marine Le Pen. The departure of other major economies from the E.U. could jeopardize the stability of the common economic area.

The election of Donald Trump as President of the United States was a similar vote for populism in the world’s largest economy. With plans to repatriate jobs and renegotiate trade agreements, Trump could destabilize Mexico, China, and other major trading partners, while reducing domestic and international growth prospects.

Trump’s unpredictability could also increase the risk premiums assigned to U.S.-based assets.

These populist agendas could also have a negative impact on emerging markets, according to World Bank officials, by negatively impacting trade and transmission mechanisms. In addition, many experts believe that the rise of populism in the developed world could spur similar sentiments from emerging market leaders. Implementing these policies in export-dependent economies could worsen problems like poverty and income inequality.

Hedging Your Portfolio

International investors have ignored political risk in developed economies for many years, but these risks have become extremely important in recent months. It may be tempting to move into cash or buy gold during risky times — especially with lofty equity valuations in much of the world — but this tends to be a poor decision for most investors.

After all, the S&P 500 is sharply higher following Trump’s election and the FTSE 100 is higher following the ‘Brexit’.

Investors have several different options to address these risks:

  • Keep Steady. A large body of research shows that timing the market is nearly impossible and most investors are best off investing over time.
  • Smart Beta. Smart beta and long-short funds provide diversified portfolios with potentially lower risk and controlled exposure than market cap weighted funds.
  • Value Investing. Value investing is a great way to avoid overpaying for an asset while creating a price floor for the asset.

The Bottom Line

The rising tide of populism around the world could be problematic for long-term GDP growth in developed and emerging market economies. Despite these risks, investors should remain in the market and try alternative strategies to reduce risk without trying to time the market.