When French far-right and anti-euro candidate Marine Le Pen drives more news stories than US and European central bank governors Janet Yellen and Mario Draghi, one can only conclude that political uncertainty is on the up. It has indeed become one of investors’ main concerns, especially ahead of the forthcoming national elections in France and, later this year, Germany.
Since thousands of young Spaniards camped in Madrid in 2012 to protest against the establishment, the populism movement has only increased in size and become global. Last year, anti-establishment leaders started to gain crucial votes, mainly the US election and the UK’s referendum to leave the European Union (EU). Non-traditional political candidates are becoming more popular, threatening the status quo and making political risk become one of the biggest concerns of investors.
Concerns, however, have somewhat abated following the poor result of populist, anti-euro candidate Wilders in the Dutch election in March. But Europe still has two major elections ahead, starting in France on April 23, with a second round on May 7, followed by the German vote in September. Both elections include anti-euro candidates who, if victorious, could seriously challenge the European project and destabilise financial markets.
The rise of populism has been brewing for years, especially since the 2007-2008 financial crises destroyed billions of dollars in wealth, left thousands unemployed and governments with piles of debt. Despite central banks’ efforts to flood the market with monetary stimulus, most developed market governments, especially in Europe, closed the taps and imposed domestic fiscal restrains to keep their deficits in check. Popular discontent increased, and so did income inequality.
Income distribution inequality has increased over the past decade... (measured by the Gini coefficient, where 0 represents equal distribution, and 100, perfect inequality)
Source: Bloomberg as of 9 March 2017. The Gini coefficient measures the extent to which the distribution of income among individuals or households within an economy deviates from a perfectly equal distribution.
...so popular discontent has pushed up political uncertainty idices:
Source: Bloomberg as of 6 March 2017. The index used is the Global Economic Policy Uncertainty Index with Current Price Gross Domestic Product Weights, from Baker, Bloom & Davis. Please find definitions in the disclaimer.
Voters also were disillusioned with globalisation, one of the forces that had increased corporate profits since the 1990s, bringing wealth to some, and leaving others behind. But by the time protestors occupied Wall Street in 2011, globalisation was already in retreat: the cost cuts that multinationals enjoyed when producing abroad reached some limits, and some Emerging Markets (EMs) improved their technology and knowledge, narrowing the gap with the richer nations. EM salaries rose in key manufacturing locations, such as China, making production abroad less attractive. Corporate profits stagnated, deepening domestic woes, especially right after the crisis.
Once-heralded global public figures, such as the elites schmoozing at the World Economic Forum in Davos, became vilified, while unconventional leaders became more popular – for example, US president Donald Trump or French nationalist Le Pen. Britain voted to exit the EU in mid-2016 and political uncertainty rose to unprecedented heights. Political risk is now especially prevalent in Europe, especially ahead of the 2 elections.
What are the chances of a major disruption in each country? Let's look at the first one:
Election date: The Presidential election has two rounds, on April 23 and May 7 (if no absolute majority is won in the first round). In June, French citizens will vote again to elect the members of the National Assembly, the country’s Parliament.
Candidates: The traditional left-wing Socialist (led by Benoit Hamon) and right-wing Republican parties (led by Francois Fillon) are challenged by new incumbents: on the left, former economy minister (under the Socialists) Emmanuel Macron founded his own party, En Marche, although he doesn’t position himself as neither left nor right. He is pro-Europe and has advocated for a Eurozone finance minister. He also wants to improve France’s labour market flexibility. On the right, anti-euro candidate Marine Le Pen has taken her father’s Front National group well beyond a minority party. She wants to regain border controls and do a referendum on European Union membership — a potential Frexit.
This is one of the most contended French elections in a generation, which has also been influenced by scandal: Le Pen’s chances increased in February on allegations that right-wing rival Fillon had employed and paid his wife and two children for fake jobs. He is still in the race.
What are the key issues? Increasing immigration is a key topic in a country already battered by recent terrorist attacks.
What are the polls saying? Macron leads polls with a 57% chance of winning, followed by Le Pen, with 27% (as of April 10). Macron has benefited from the demise of Hamon’s Socialist Party, whose chances have fallen partially due to the unpopularity of the incumbent Holland’s government. Le Pen’s case has fallen, from a peak of 34%, as Macron’s popularity increased and his campaign intensified — he travelled as far as London to recruit thousands of disillusioned French expats.
Expected outcome: Le Pen may fare well in the first round against a divided left, and helped by Fillon’s demise and by the refusal of ex-prime minister Alain Juppe to replace him as leader of the Republican party. However, Le Pen may not win a second round, when she would contest a major candidate. In such scenario, polls say that Macron or (before) Fillon, would snatch a victory.
How has the market reacted? French sovereign spreads over German bunds have closely matched Le Pen’s victory chance: they almost reached 80 basis points at the height of Le Pen's popularity, only to back down to 56 bps after her partial demise. They were trading at 71 basis points on April 10.
What are global markets telling us about risk?
Financial markets are painting a rosier picture, based on a reflation idea that started last year, when China unveiled a monetary stimulus to avoid an economic hard landing. The world’s second-largest economy has been able to maintain growth at above 6.5%, annualised, at the same time that a manufacturing crisis in the US has abated. The US central bank says it is ready to continue hiking rates, a sign that the economy is heating up. Finally, Europe and Japan also seem to be waking up after years of dormant growth.
So, are markets wrong or is the increase in political uncertainty overstating real risks? Or both? Click here for the opinion of Western Asset's Andrew Belshaw.
As it is often the case, uncertainty seems the only certainty. But some investors believe that chances of a fast and sharp global growth rebound remain slim: Europe still needs to go through two national elections and Britain’s departure from the EU; US markets have priced in a successful outcome of policies that still may take more than a year to come into effect; Japan, while improving, is far from full traction, and China is heavily overleveraged.
Investors also worry that while the issues that have caused the popular discontent aren’t resolved, political uncertainty won’t abate. Populist candidates may not emerge victorious in this year’s European elections – but what about the next round in a few years’ time?
What can investors do?
Against this backdrop, picking the right asset class, country, sector or issuer will be crucial for performance. In order to maximise opportunities, investors with a flexible approach will be able to have a bigger selection of assets, without the constrains of traditional benchmark indices. These are normally skewed towards long-only, developed market, highly leveraged issuers, in the case of fixed income, or towards the largest companies, in equities.
Bond and equity markets are much bigger than that: they also include Emerging Markets, smaller or lower rated companies, bank or infrastructure loans, derivatives, inflation-linked or asset backed securities, all in either developed market or Emerging Market currencies. A flexible manager can also use long or short strategies to profit in both up and down markets.
Experience and knowledge has helped active asset managers weather numerous wars and crisis throughout history. 2017 appears challenging, but also because of this, full of opportunity.