“We could see a double-digit down year as part of the process,” he continues. “Over the last 25 years bonds have massively outperformed equity. We could see a two-to-three year period where all that gain is reversed if bonds go down and equities go sideways.”
DANGEROUS MYOPIA
The initial reaction to more inflationary policies in the US and UK has been positive with the Dow Jones and FTSE breaking fresh highs, but this may be another symptom of myopic thinking and some degree of ‘populism blindness’ as investors fail to grasp the potential gravity of the movement and its long-term impacts.
“In a sense the market has moved on by focusing on a very narrow set of expectations on a narrow part of the policy,” according to Salman Ahmed, chief investment strategist at Lombard Odier Investment Managers. “There is a much bigger shift happening though,” he warns, pointing to potential trade tensions and lower growth if policy shifts towards more protectionism and less freedom of movement of labour.
“These factors are not priced in,” he says, “which can lead to volatility.”
Volatility is already higher, particularly in foreign exchange markets where ETF Securities’ Butterfill says currency vigilantes are having a significant effect. The meaningful swings in the dollar and sterling following comments by Donald Trump and Theresa May are evidence of this. As MSCI points out, history also demonstrates that populist policies have a tendency to lead to stagflation, low economic growth driven by more-restricted trade and inflation spurred by excessive public borrowing.
STILL EARLY DAYS
Last year was only the start of a long-term and profound change in the political and economic supercycle. All eyes are now focused on Europe where 2017 will see a very busy election schedule covering many of the key markets in the eurozone, including Germany, France, Italy and Holland.
In the latter three countries, populist parties are leading the opinion polls and anti-euro sentiment is growing. Marine Le Pen has already made clear her desire to leave the eurozone.
“Europe could look very different in a year’s time,” according to Butterfill.
Any significant threat to the eurozone would severely damage peripheral bonds and equities as it becomes unclear how countries and companies within them will be able to refinance their debt, for example.
Even if there are no populist party wins in Europe this year, it will certainly be difficult for the region to continue with the current status quo. Even in opposition, the populist parties will have a marked influence on the policy direction as incumbent leaders scramble to keep their voter base.
