"Fruitcakes, loonies and closet racists” was how David Cameron described members of Ukip in 2006. A decade later, Ukip has achieved its principal ambition of a Brexit vote and Cameron is no longer a politician.
The growth in support for populist political movements across Europe and other developed economies has been rapid. Founded just six years ago, the Five Star Movement has surged in popularity in Italy, and a recent poll shows that Marine Le Pen, leader of France’s Front National (FN), would win 30 per cent in the first round of presidential voting.
A Le Pen win still looks unlikely, not least because supporters of France’s Socialist and Republican parties have a long history of voting tactically to block her party from office. But even without major electoral success, such insurgents are proving increasingly able to influence the agenda of incumbents, particularly when it comes to issues such as free trade, immigration and corporate governance. Each of these could weaken the economy and have an adverse impact on business performance.
So what do investors need to know about these groups, and how can they arrange their portfolios for a more populist era?
“All populist parties tend to prompt volatility,” says James Butterfill, head of research and investment strategy at ETF Securities. In many ways, markets don’t discriminate, they just don’t like change. “When there is a change in administration in the US, you tend to see greater instances of volatility,” he notes. The Mexican peso, the world’s most liquid emerging market currency and a proxy for global risk, has been battered as polls have moved in Donald Trump’s favour, and even by Brexit, despite Mexico’s lack of exposure to the British economy. Since the referendum, sterling has fallen at any sign from the government that the UK’s trading relationship with the EU will change.
Instability tends to benefit gold and defensive equities, which include utilities and basic consumer goods companies, though their performance is by no means guaranteed. Another option is to hedge against volatility more directly, by buying futures contracts based on the forward price of the Vix volatility index.
It takes all sorts
While market uncertainty may be the short-term result of a surge in popularity for, or increased influence of any populist party, it would be a mistake to assume that they all want the same things. Investors should be aware of exactly which policy areas populists could shape in different countries. As a term, “populism” resists any particular definition. John B Judis defines it not as “an ideology, but a political logic – a way of thinking about politics.” He distinguishes between left-wing populists, such as Syriza, who represent the bottom and the middle against those at the top, and right-wing populists who champion the people against an elite accused of favouring a third group – immigrants or Islamists, for example.
Even among those on the right, there are stark differences. The FN’s protectionist calls for higher import duties to shield French manufacturers contrast sharply with the Dutch Freedom Party’s celebration of free trade. Nevertheless, both of these parties are eurosceptic and would curb immigration.
But even if they exhibit differences, the reasons for the rise of these parties are broadly the same. Years of tighter public spending which followed the financial crisis have coincided with a period of stagnant real wages and growing income inequality between the very rich and the middle and lower classes. Many blame QE and low interest rates for punishing savers and inflating the value of assets such as property. Added to this is a growing cultural diversity – the product of higher levels of immigration particularly in a free-moving Europe – and the result is a disgruntled populace desperate for change.
Even without major electoral success, these insurgents are proving increasingly able to influence the agenda of incumbents, particularly when it comes to issues such as free trade, immigration and corporate governance
A report in March by MSCI reviewing the proposed policies of Europe’s populist parties found a broad intersection in their calling for greater sovereignty, tighter rules around trade and the need to end austerity. It predicted that if populism rose across Europe and the US, favouring protectionism and government spending, and produced the unhappy combination of higher inflation and low growth, even broadly diversified portfolios could lose between 8 and 11 per cent of their value. Equity, sovereign and credit debt markets could all be hit, with countries on the periphery of Europe suffering most. With greater government spending on infrastructure and defence, industrials could gain relative to the rest of the market.
In their 1990 paper on macroeconomic populism, Rudiger Dornbusch and Sebastian Edwards studied the economic programmes of Chile’s Salvador Allende and Peru’s Alan Garcia, both of whom raised public spending significantly.
First, higher public spending was found to stimulate demand and increase output, vindicating policymakers who look to be delivering on their promises. Employment and wages rise, price controls keep inflation steady, while reserves are spent on imports to keep the new demand satisfied.
Read more: Greek PM says austerity caused Brexit
During the second phase, price realignments, currency devaluation and increased protectionism become necessary to keep wages rising. This gives way to hyperinflation. With a widening budget deficit, the government becomes unable to keep up its fiscal expansion. Wages fall, unemployment rises, a recession occurs and investors clamber to get their capital out.
Finally, a new administration takes over. Depressed investment and a decapitalised manufacturing sector will have diminished real wages. It is, ultimately, the domestic workforce, and not investors, who suffer most. “Capital is mobile across borders, but labour is not,” they write. “Capital can flee from poor policies, labour is trapped.”
Hyperinflation is unlikely to be a worry in developed markets because higher public spending would require approval from a number of political institutions. “There would be a lot more policy gridlock than there would in the emerging world,” says Butterfill. “But you'd certainly get inflation.”
Rising prices push up the yield on inflation-linked bonds. While inflation is already happening in the US and is starting to pick up in UK, expectations for price increases remain low in Europe, making this “an opportune time for long-term investors to build positions in index-linked products,” says Butterfill.
Capital can flee from poor policies, labour is trapped
Of course, for governments in the Eurozone, there is a limit to the scope of any anti-austerity programme. Unable to devalue the shared currency to boost its growth, Greece’s ruling party Syriza has choked down austerity in return for much-needed bailout funds, much to the disappointment of its supporters. An automatic fiscal stabiliser is in place to cut pensions, salaries and other forms of spending if the country deviates from any of its agreed annual fiscal target, and the Greek parliament is powerless to stop it.
It would be unwise to prophesy the breakup of the Eurozone or EU quite yet. But Matteo Renzi’s promise to resign if he loses the Italian constitutional referendum in December has effectively made it a vote either in support of his technocracy, or for the eurosceptic and protectionist inclinations of the Five Star Movement. Italeave, or even Frexit, are not outside the realms of possibility.
Since Britain voted Leave in June, sterling has fallen significantly in value, and any exits from the Eurozone would likely weigh hard on the euro. “Every sovereign wealth fund which has built up a euro reserve position over the last 16 years must be panicking,” wrote David Zervos, chief market strategist at Jefferies in the days following the Brexit vote.
Depending on whether the eurosceptic mood was being motivated by an opposition to austerity, immigration – or both – and whether the departing member was a popular destination for migrants from the rest of Europe, the economic impact of leaving would be different. Migrants to western Europe are employed in large numbers in food and clothes manufacturing, construction and hospitality.
Other sectors which have benefitted tangibly from European integration include those with cross-border supply chains, like car manufacturing, or financial services, which serves customers across the bloc from a single base.
Matteo Renzi’s promise to resign if he loses the Italian constitutional referendum in December has effectively made it a vote either in support of his technocracy, or for the eurosceptic and protectionist inclinations of the Five Star Movement
Until recently, German Chancellor Angela Merkel has been driving the EU bus. But her refugee policy has weakened her popularity at home and she may not survive next year’s election, which may allow existing fractures to become deep fissures. European Central Bank (ECB) intervention has until now ensured that credit spreads in the euro area have been capped, but calls to raise interest rates (particularly from Germans) and to end the stranglehold of the ECB, could cause things to change very quickly.
Of course, the economic worries which would follow another exit would put pressure on the European Commission to speed up economic integration, which would lead populist voices to decry the death of national sovereignty even more loudly.
Tough on corporate greed
A survey by the High Pay Centre found that the bosses of FTSE 100 companies received a 10 per cent pay rise last year, with an average salary of £5.5m. Stagnant and almost stagnant wages across Europe have fuelled criticism of executive pay and lax corporate governance.
In her first speech as Prime Minister, Theresa May embraced this anti-corporate sentiment by vowing to put workers on company boards and abolish advisory shareholder votes on pay. This isn’t likely to impact on a firm’s top line, argues Butterfill. “It’s never just one person making a decision, and it is unlikely that workers will have very different views from the rest of the board, which is what people seem to be implying.”
But caps on executive pay might have a more tangible impact on a company’s returns. London Business School’s Alex Edmans has said that a pay ceiling would incentivise the preservation of the status quo in the C-suite, rather than the kind of risk-taking which is necessary to take a good firm to greatness.
Other proposals go much further, and attack shareholders’ interests directly. In January, Labour’s Jeremy Corbyn called for a ban on businesses paying dividends to shareholders if they depend on “cheap labour” to do so. As Simon Walker, director general at the Institute of Directors, said at the time: “Paying a dividend is not an immoral act, pensioners are dependent on them for their retirement, and without them, investment in British companies would dry up.”
This article appears in the upcoming edition of Money magazine, which will be distributed free with the paper on Thursday 27 October.