Investing in an age of populism…

2016’s been accepted as a watershed year: a year where we saw a rise in populism in the West.

There’s been countless articles and commentaries written on this rather (un)eventful year, so I shall not add to the existing pile. As global macro investors, we are well aware that developments in the political realm can lead to changes in geopolitics, economics and global finance, as well as having social implications. Thus the rising trend of populist politics in the Western developed economies warrant close monitoring as well as diligent study.

In particular, this current trend across the Western world tends to display common traits or patterns. Elements such as anti-establishment, anti-free trade sentiment and a general movement to the right can be observed. A revival in nationalist fervour could also be seen, and considering all the combined factors, it may possibly mean a start of a reversal of what we have seen over the past 5 decades of global integration and cooperation (led by a bi-polar Soviet-US world). This was rather aptly illustrated by the following cover art from The Economist:

economist

Financial markets tend to look to the future and anticipate it, discounting future developments into current prices. Hence, the uncertainty caused by the rise of populist politics is somewhat increasing the expected level of volatility among asset prices, and this could even perhaps form a norm moving forward. The current situation is also made more complex given the inherent unpredictability of this age’s leaders (think of Trump & Duterte).

There are 2 possible main drivers of this ‘frustration of the middle/lower classes against the global elite’.

We all know about the ‘Elephant Curve‘; many are of the opinion that globalisation has only helped a small percentage of the overall population and left many behind, leading to a rise of wealth and income inequality, which fueled resentment against globalisation and free trade. Thomas Piketty’s chart below indicates the situation in the US. The real reasons behind this rise in in wealth inequality can be quite complex and is beyond the scope of this article. A rise in populism and politicians who are riding that trend could lead to forced distributions of wealth sometime down the line. According to Bridgewater Associates, wealth distribution actions by politicians are typical of deleveraging phases of long term debt cycles, so what is happening shouldn’t be that surprising given where we are in history (at the end of a long term debt cycle).

Income_Disparity_

Another possible driver (which could also be fueling rising income inequality) is the secular trend of automation and artificial intelligence (AI). This is a somewhat complex factor, but a big-picture view of the situation would leave one with the impression that more and more lower-skilled jobs would be fully automated away, leaving lower-skilled workers at the losing end of the stick. The people owning the technology and capital would essentially be the winners, and probably the survivors of this high stakes game that we find ourselves in. They will also be the targets of populist politicians.

Here’s a prescient chart from BlackRock illustrating manufacturing trends in the US:

us-manufacturing

Notice that since the mid-70s, manufacturing production has been on an upward trend, and yet the percentage of the labour force engaged in the manufacturing sector has declined. This decline in manufacturing jobs is particularly acute since 2000 (almost 30% decline in the number of employees in US manufacturing). However, this is not only seen in manufacturing – advances in AI could have a bigger impact on white-collar jobs in service industries. In our world today, technological innovation is increasingly rapid, displacing many traditional jobs and changing industries. It’s entirely possible that technological change is also fueling populist politics around the world, whereby people are increasingly fearful of their future and are unable to keep up with the pace of change. And this could be a reflexive relationship whereby continued automation and AI development directly feed into more resentment, leading to more radical populism…

With the above being said, global investing is getting more challenging moving forward. Here are some broad-based measures to consider to mitigate some of these issues:

  • Decrease exposure to multi-national corporations that are vulnerable to a lashback against globalisation and free trade (perhaps consider domestically-orientated companies?)
  • Avoid areas that could be affected by a lashback against automation and the employment of AI (tech companies that are global and highly disruptive in their business models), especially if opportunistic politicians target those areas to directly fan the fires of populism and ride its trend…
  • With the rise of nationalism and possible lashback against globalisation from several regions across the world, having exposure to industries that benefit from such developments could serve as a natural tail risk hedge in one’s portfolio (think defense/military for example)
  •  While the total reduction of free trade globally is highly unlikely, any possible movement against it could quickly deteriorate the situation and lead to volatile movements in currency movements and financing costs (think of tariff threats between trading partners)

We all know that logically speaking, many of these populist measures, if implemented, would lead to a reduction in the free movement of peoples, capital and goods and services, which is actually negative on global GDP growth. However, when it comes to the current populism that we have observed thus far in 2016, it is highly emotional and irrational, thus we have to be mindful of these risks as we navigate this rather interesting times ahead…

*Image credits to www.dissentmagazine.org & The Economist*


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