Economic insecurity, social insecurity and political ineffectiveness: these developments have fed a resurgence of populist policies in many regions of the world. We think there’s potential for major impacts on global capital markets.
We expect populist policy changes to take aim at areas such as trade protection, immigration, higher taxes on corporations and high-income earners, and big wage increases. All these policies tend to be inflationary, so it’s likely that populism will boost inflation rates over the medium to long term.
But that’s only one impact we see—investors can expect populist dynamics to have five major influences on their strategies:
1) A SECULAR INCREASE IN INFLATION. A greater willingness to use fiscal stimulus alone has the potential to lift inflation, particularly because central banks are likely to keep interest rates low to ease the process. Against this background, populism could make a stronger political case for aggressively pursuing growth, which would increase inflationary pressures.
2) DOMESTIC FACTORS WILL BECOME MORE IMPORTANT. Policies that “raise the drawbridge” by attempting to counter global trade patterns will bring national factors to the forefront. Not all countries will embrace populism—at least not to the same degree. So, we expect a wider variety of economic outcomes across countries.
3) BOND YIELDS AND RISK PREMIUMS SHOULD RISE—AND SO SHOULD DISPERSION. With economic outcomes becoming more varied, investors will see bigger differences among returns in the world’s bond markets. Higher inflation rates should cause bond yields to rise—and will likely lead investors to demand higher yield premiums for bearing the risks of holding nongovernment bonds.
4) POLICIES WILL BE LESS BUSINESS FRIENDLY. A trend toward raising the drawbridge on trade policies and shifting toward policies that aim to redistribute income and wealth could move a greater share of income away from business owners and toward wage earners. There are certainly countervailing forces. These include the rise of artificial intelligence, which may weaken workers’ bargaining power. On balance, though, we expect populist policies to drive a reversal in the secular rise of profit share—this would likely hurt risk assets.
5) IMBALANCES AND DISLOCATIONS WILL BE EXPOSED. The move toward a more populist-driven policy agenda will expose imbalances and dislocations in the global economy. The imbalance between the uniform single currency in the European Union (EU) and the underlying economic disparities between member EU states remains a potential flashpoint.
These trends have the potential to redefine the global investing landscape. But how long will it take for these forces to play out? And how forceful should we expect their effects to be?
That answer is partly related to the broader health of the global economy. As long as there isn’t a global recession, we would expect these forces to play out gradually—perhaps over a three-to-five-year time frame. But if the global economy were to hit the rocks in the next year or so, these risks would crystallize much more quickly…and probably much more forcefully.
When the US Federal Reserve released the results of its Comprehensive Capital Analysis and Review (CCAR) in late June, it marked a dramatic moment for beleaguered US banks. In one fell swoop, the annual stress tests confirmed that banks aren’t mired in a regulatory quagmire anymore. Instead, they’re strong American companies that seem fully recovered from the global financial crisis of 2008.