OPINION | While it is important for investors to be mindful of the populist movement in the United States and Europe, they shouldn’t be overly fearful. There are two reasons to stay calm and take a more balanced investment approach toward the movement: First, both the US and Europe are democratic societies, and second, they are capitalist societies.
Democratic societies are governed by constitutions; the rule of law is their foundation. The existence of constitutions and democratic processes trumps all – pun intended. Therefore, no matter how extreme the endeavours of elected populist leaders, their power to implement change is limited by the checks and balances of the democratic process written in constitutions. This critical fact will endure so long as populists have minority representation within government, as is now the case in America and Europe.
There is another calming element to consider when weighing the impact of populism on democratic societies – elections. In the same way that populist candidates can be voted into power, they can also be voted out. Supporters of the populist movement may decide they don’t like the populist candidates they put into power, resulting in a second phase of the movement. In this case, investors should focus on whether voters would be more likely to return to supporting traditional candidates or back candidates who are even more extreme than the ones elected in the first phase.
Capitalism’s calming influence
Whatever the case, whomever populist voters choose would remain bound by national constitutions, which, for investors, should outweigh fear of change.
Capitalism is the second calming factor. History has demonstrated the power of the ‘invisible hand’ in capitalist societies, where nations have thrived and built wealth despite a plethora of challenges.
Consider the case of the United Kingdom and its decision last year to vote in favour of leaving the European Union. It wrought a great deal of fear about the outlook for the UK economy, which manifested for a short time in a relatively modest decline in its sharemarket. Ever since then, the market has reached new highs, gaining a whopping 20 per cent. What happened? Investors focused on the outlook from the bottom up, which is to say they focused on how companies would adapt and fare after the vote, picking winners and losers, while on the whole concluding that a rebound in corporate profits in the UK and around the world trumped all.
Stocks versus bonds
Probably the most telling sign about how global investors truly feel about Brexit and the election of Donald Trump can be found in a comparison between how the share and bond markets have performed since the US election. Equities have soared, and while the US 10-year Treasury note jumped sharply from about 1.85 per cent to as high as 2.6 per cent (now about 2.4 per cent), the bond market remains priced for the Federal Reserve to increase its policy rate to just under 2 per cent in the year 2020, and to about 2.5 per cent 10 years from now. That’s far below the peaks of 5.25 per cent, 6.5 per cent and 6.0 per cent in the last three rate-hike cycles, which ended in 2006, 2000 and 1995, respectively.
Separately but similarly, markets are priced for both the Bank of Japan and the European Central Bank to keep their policy rates near zero through the rest of the decade.
The point is that the bond market is skeptical that the new US administration will be successful in spurring a permanent increase in the trajectory on US economic growth. The equity market, on the other hand, is priced for a pickup in corporate profits, which is completely different from the sort of economic growth that can boost inflation – the bond market’s nemesis.
In sum, investors should consider the importance of the structures of democratic and capitalist societies during this era of populism, as well as staying focused on the long-term drivers of economic growth, rather than short-term measures.
This article originally appeared in Nikkei Veritas’s Market Eye column, in Japanese, on April 9.
Tony Crescenzi is a market strategist and generalist portfolio manager at PIMCO.
