Geopolitical risk and acts of war have historically had a passing effect on financial markets. Today’s wave of nationalism, as exemplified by the election of U.S. President Donald Trump, could have a longer lasting impact on financial markets should it lead to protectionism.
A passing effect?
When people think of extremism, the first thought that comes to mind is likely to be acts of terrorism or war. Events such as conflicts between two states, civil wars and major terrorist attacks take a large humanitarian toll. They also cause damage in financial markets, though perhaps not as much as one would expect.
For instance, consider how the Dow Jones Industrial Average reacted to 30 major acts of war since the U.S. dropped a nuclear bomb on Hiroshima in 1945. On average, the index declined by 4% over seven days before recovering losses within 26 days. On just four occasions the market fell by more than 10%.
However, there is another form of extremism other than acts of war. Today, we are witnessing the rise of populism around the western world as globalisation, a widening gap between the rich and the poor, and declining trust in the establishment, have stoked anger amongst many. To the extent that this threatens the standards which have underpinned economic expansion over the past four decades, the impact on financial markets could be greater.
A different type of extremism
Globalisation and immigration have brought us plenty of benefits, but many people feel they have been left behind as they have seen their jobs lost to cheaper labour, whether through offshoring or immigration. Similar to the popular uprising in Voltaire’s France, our current state of politics reflects not only concerns about income inequality, but also declining trust in the elite. Support for fringe parties that challenge the mainstream has grown.
The U.S. is a prime example of this trend. Those Americans who have just a high school diploma or lower are losing ground as their median household income has been in decline since the late 1990s. The bottom 50% of the population has seen its net worth shrink drastically in the past decade, while at the other end of the spectrum, the net worth of the top 10% has remained stable. President Trump’s policies regarding immigration and trade could hinder the U.S.’s growth prospects in the long term. Protectionism in particular is a threat as it often leads to retaliation, resulting in disputes escalating.
In Europe, concerns about inequality and immigration have led to support for parties that are anti-immigration and anti-European Union. This issue has come to a head in 2017 as countries representing at least 50% of the EU’s economic output have had or are holding elections. Emmanuel Macron’s victory in the French presidential election over Marine Le Pen of the anti-EU National Front went some way to calming these fears; however it does not necessarily herald an end to the rise of populist sentiment in the country given that some 44% of young voters supported Le Pen.
Potential upsets from Europe’s heavy political cycle are not over. While the September German elections are expected to produce a centrist government, Italian elections pencilled in for early 2018 could prove more problematic. The confluence of Italy’s importance as Europe’s third-largest economy, its heavy indebtedness, the precarious state of its banking system, and growing anti-EU sentiment could conspire to make this a preoccupying event. However, the ruling Democratic Party has recently re-established its lead in public opinion polls over the populist, anti-EU, Five Star Movement.
Investing in an age of extremism
The recent rise in populist extremism and the protectionist attitudes that they foster are a threat to financial markets. Investors should remain alert.
From an equity investing perspective, we continue to be biased towards investing in quality companies, those seeking to allocate capital efficiently, generate returns over the cost of capital and ideally display secular growth characteristics – where a company can generate growing revenue regardless of the economic cycle.
These could include:
- An ageing population that will consume more pharmaceuticals or retirement savings products;
- The growing urbanisation of cities as more homes are built, more office buildings are constructed, or more lifts are installed;
- The burgeoning millennial generation and their differing spending patterns compared with baby boomers or Generation X.
We remain alert to the risk of protectionism as the inevitable retaliation which follows is destructive to economies and financial markets. For now, with the global economy continuing to expand, financial markets have been resilient, and so long as there are no signs of recession, we think the outlook for equities remains constructive. We continue to be biased towards investing in quality companies.
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