Download Implications of the rise of political populism

James Butterfill
Head of Research & Investment Strategy
Maxwell Gold
Director of Investment Strategy
ETF Securities Outlook
September 2016
Implications of the rise of political populism
Summary

Populist parties are leading the polls in many developed world
countries due to inequality, weak economic growth and a
disenfranchised electorate.

Populist policies may likely lead to inflation, so investors may
protect portfolios from populism by targeting assets which
perform well in an inflationary environment.

Inequality and quantitative easing (QE) appear to go hand-inhand. Whether it is the cause or effect is not yet known.
Defining populism
Something unusual is happening in modern politics that is
threatening to destabilize incumbent political parties in the
developed world. Populism is a term being used more and more in
the media although there isn’t much consensus on its definition. An
academic paper written by Ionescu and Gellner in 1964 suggested
that “populism worships the people”, and questioned if it had an
underlying unity or the name covering a multitude of unconnected
tendencies. In some respects, it isn’t an ideology but a mode of
political expression that is employed selectively and strategically,
targeting issues of mass appeal.
Exhibit 1: Populist party polling
49
Brex it UK
T rump US
% of t ot al polling
44
39
FPO Austria
34
5* Italy
29
Le Pen France
24
03/2016
04/2016
05/2016
06/2016
07/2016
08/2016
09/2016
Source: RealClearPolitics, Wikipedia, ETF Securities. Exhibit data from 03/01/16 to
09/08/16. See important information for further details.
The term populism in today’s context is similar, in that it reflects a
varied demographic, being an eclectic group of voters from both the
left and right. The issues are often viewed as the ordinary man
oppressed by a remote elite to issues regarding immigration or
national sovereignty. The European Union (EU) Referendum in the
United Kingdom (UK) highlighted how seemingly arcane issues can
rapidly become a mainstream school of thought. This rise of
populist politics in the UK is being mirrored across the developed
world with many populist parties rising in the polls and often
leading in them (see Exhibit 1).
Populism – why now?
Populist parties in the EU have grown significantly in recent years.
Typically, the agendas of these parties have focussed on a break
from the incumbent political establishment. Populist parties tend
to overpromise, developing simple policies with mass appeal,
irrespective of their ability to be delivered.
Why has this phenomenon begun now? Some key drivers of today’s
rise in populism, primarily high inequality, seem to be generated by
stagnant economic and wage growth alongside increasing cultural
diversity. But in the UK for instance, traditional indicators such as
the GINI coefficient suggests the income gap has shrunken,
although we believe this is potentially misleading.
Inequality and stimulus
Though inequality is notoriously difficult to measure, the
traditional metric, the GINI coefficient, has issues in the populism
context as it is insensitive to the differences between the richest and
poorest. Populism is associated with the ordinary man being
oppressed by a remote elite. Therefore a more appropriate metric
for inequality would be the Palma ratio, which measures the ratio
between the top 10% of earners to the bottom 40% (see Exhibit 2).
Exhibit 2: Palma ratios (2013/14) across the OECD
Chile
Mexico
United States
Turkey
Israel
United Kingdom
Spain
Portugal
Greece
Italy
Canada
France
Germany
Austria
Norway
Iceland
0
0.5
1
1.5
2
2.5
3
Palma ratio
Source: Bloomberg, ETF Securities. Exhibit as of 09/08/16. OECD = Organization for
Economic Cooperation and Development. See important information for details.
1
Past performance is no guarantee of future results.
Quantitative easing does appear to be exacerbating inequality.
Taking the average Palma ratio of those countries in Europe where
populist parties are leading in the polls, namely Austria, France,
Italy and Spain, there is a positive correlation between the two.
Regardless of the success of populism at elections, populist
momentum can be a very powerful catalyst for reform, with
incumbent parties scrambling to counter the populist wave. The
end result is typically a rise in infrastructure spend to stimulate
economic growth and social initiatives to combat inequality.
Infrastructure spend creates additional demand while social
initiatives are likely to lead to an increase in consumer spending
with the end result being a likely rise in inflation.
Exhibit 4: The impact of uncertainty
2700
1.14
2200
1.12
1.1
yoy change
3200
1.16
European Central Bank
Balance sheet (lag-1yr) (RHS)
1.08
2003 2005 2007 2009 2011
60%
100%
Russell 1000 defensives/dynamics (RHS)
50%
60%
1700
EUR billions
Depriv ation as a % of total population
Av erage Palma ratio of Spain, Italy ,
France, Germ any & Austria (LHS)
Policy Uncert ainty Index (US + Europe) (LHS)
80%
Exhibit 3: Inequality versus Quantitative Easing
1.18
120%
40%
defensives outperform
30%
40%
20%
20%
10%
0%
0%
-20%
-10%
-40%
-20%
-60%
-30%
dynamics outperform
-80%
1998 2000 2002 2004 2006 2008 2011 2013 2015
relative yoy change
Gabriel Palma, who developed the ratio, implied in his work that
globalization is creating a distributional scenario in which what
really matters is the income-share between the rich and lower
income workers with ever more precarious jobs in ever more
‘flexible’ labor markets. What the Palma ratio highlights is that
some of the greatest inequalities in the OECD are places where we
have witnessed some of the most significant populist uprisings.
-40%
1200
Source: PolicyUncertainty.com, Bloomberg, ETF Securities. Exhibit data from 1/1/98
to 09/08/16. See important information for further details.
700
Rising inflation from populism could add to already strong
inflationary pressures in the US. Supply-side destruction in
commodities could add further waves of inflationary pressure. In
an inflationary environment, index linked bonds are likely to
perform well. With inflation expectations particularly low at this
juncture it is an opportune time for long-term investors to build
positions in inflationary sensitive assets including index-linked
products.
2013 2015
Source: OECD, Bloomberg, ETF Securities. Exhibit data from 1/1/03 to 09/08/16. See
important information for further details.
Inequality and QE appear to go hand-in-hand (see Exhibit 3). Is it
cause or effect? We do not know yet. But what is clear is that QE
has been very beneficial for equities and bonds and that only the
relatively wealthy have access to them.
Populism – implications for investments and
the economy
One of the more immediate effects of populism has been the rise in
uncertainty prompting investors to flock to high quality and
defensive equities. Historically there has been a close correlation
between rising uncertainty and an appetite for defensive equities
(see Exhibit 4). Although not as strongly correlated, demand for
gold, often seen as a potential safe haven, rises in times of rising
uncertainty.
When populists have historically won in emerging markets, there is
often a rise in infrastructure spending which temporarily raises
growth in output, real wages and employment, but quickly gives
way to hyperinflation which erodes the initial gains. But in the
developed world populists in opposition tend to be more successful
than populists in office, since populists are often inexperienced
politicians and the barriers to reform implementation are too
difficult to overcome.
Populist policies in the US, which are likely to include tax cuts,
prompting a widening of the budget deficit, could weaken the US
dollar in the coming years. Furthermore, protectionist policies that
could constrict international trade and investment are likely to
exacerbate global currency volatility, in turn contributing to further
investor uncertainty.
Over the coming year, there are many elections scheduled where
populist parties are gaining traction. As inequality issues cannot be
reversed overnight, we believe uncertainty is likely to remain
elevated in the coming year, favoring safer, lower volatility assets.
While rising populism doesn’t always end up with the political
incumbent losing, some populist policies are typically implemented
to assuage the disenfranchised, which are likely to be inflationary.
Investors may be able to protect investment portfolios by gaining
exposure to assets which perform well in an inflationary
environment, such as precious metals, equities, inflation linked
bonds, and infrastructure.
2
Past performance is no guarantee of future results.
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Definitions: The European Union (EU) is a politico-economic union of 28 member states that are located primarily in Europe. Brexit is an abbreviation for
"British exit," which refers to the June 23, 2016, referendum whereby British citizens voted to exit the European Union. The GINI coefficient (sometimes
expressed as a Gini ratio or a normalized Gini index) is a measure of statistical dispersion intended to represent the income distribution of a nation's
residents, and is the most commonly used measure of inequality. Quantitative Easing (QE) is the introduction of new money into the money supply by a
central bank. The Freedom Party of Austria (Freiheitliche Partei Österreichs, FPÖ in German) is a right-wing populist political party in Austria. The Five Star
Movement (5* or M5S) is a political party in Italy started by Beppe Grillo, and is considered populist, anti-establishment, environmentalist, anti-globalist and
Eurosceptic. The Organization for Economic Cooperation and Development (OECD) is a unique forum where the governments of 34 democracies with
market economies work with each other, as well as with more than 70 non-member economies to promote economic growth, prosperity, and sustainable
development. Russell 1000 Defensive Index is an equity index measuring the performance of the large-cap defensive segment of the U.S. equity universe. It
includes those Russell 1000 companies with relatively stable business conditions which are less sensitive to economic cycles, credit cycles, and market
volatility based on their stability variables. The Russell 1000 Dynamic Index is an equity index measuring the performance of the large-cap dynamic segment
of the U.S. equity universe. It includes those Russell 1000 companies with relatively less stable business conditions which are more sensitive to economic
cycles, credit cycles and market volatility based on their stability variables. The Policy Uncertainty Index is represented by the Baker, Bloom and Davis
composite index of economic policy uncertainty draws on the frequency of newspaper references to policy uncertainty and to other indicators of policy
uncertainty including expiration of tax provisions and disagreement among economic forecasts of inflation and government expenditure. Year over year =
the percent change over a full calendar year
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