The rise of populism in markets

South Africans are not alone in watching as populism, political infighting, wrangling and shenanigans stymie economic growth.

In the UK the Bank of England left interest rates on hold earlier this year, saying it expected UK growth in 2019 to be the slowest since the depths of the financial crisis a decade ago, blaming mounting Brexit uncertainty and the global slowdown. Economists have lowered their forecasts for growth in 2019 to 1.2% from a previous estimate of 1.7%.

“This is the inevitable outcome of a political decision,” says Schroders senior European economist Azad Zangana. “The UK went from being the fastest growing economy in the G7 to the slowest, growing at half the rate averaged between 2011 and 2015. New growth is from stockpiling and industry build, and that is unsustainable.”

Brexit is not the only geopolitical woe on the economic horizon. Populism is on the rise in Europe and around the globe, Zangana says. At the turn of the century, populism was a blip on the horizon of European politics. Since then, the number of Europeans voting for populist parties in national votes has surged from 7% to more than 25%, according to groundbreaking research by the Guardian. Back in 1998, only two small European countries – Switzerland and Slovakia – had populists in government. Two decades later, another nine countries do. In Poland, the government is taking steps to control private pension fund assets; in the UK the Labour Party is advocating that the Bank of England print more money to spend; and in the US, President Trump was voted in on a US-first ticket, Zangana says.

Politicians started meddling …

Historically politicians left investment markets alone. But following the global financial crisis of 2007/8, trust broke down and politicians began meddling in the financial world. “At the time the lack of regulation caused the crisis and they had to bail out the banks,” says Zangana. “But since then regulation and business rules have become burdens and the investment industry a target for politicians. 

“Now people are openly questioning liberal democracy and the capitalist system. But they forget the alternatives – communism and fascism have been tested and found wanting.” 

However investors, he says, are getting used to the noise. “In 2016, the year the Americans voted Donald Trump into power and the Brits elected to leave the European Union, volatility made a return to markets, following years of steady growth. But then investors started learning how to differentiate between noise and genuine policy change.”

That said, South African investors could be forgiven for looking at all of this and deciding that given the political uncertainty, the rise of the populists and market volatility, the safest place to invest is local – in a market that is at least predictable and which they understand.

“This is a mistake as South Africa is not a safe haven,” says Zangana. Home bias investing – where investors favour local stocks – is a well-established investment phenomenon, he says. However, this is unwise when the home market [such as the JSE] accounts for such a small percentage of the global market. “Diversification reduces portfolio risk and can be achieved by spreading investments across asset classes, time, industries, companies and geographies. South Africans are not alone in this bias – it occurs in markets across the globe.”

Since the home bias leads to geographically concentrated under-diversified portfolios, it exposes investors to large quantities of country-specific risk, which can emanate from political, social, economic or ecological events.

Looking global

Zangana advises investors to allocate a sizeable proportion of their portfolio to US stocks. “The US economy continues to grow strongly.

“If the world heads towards a full-blown recession it is likely that US assets will outperform as US home bias kicks in and dollars come home, strengthening the currency and reducing liquidity to other markets, in particular emerging markets.”

Despite being based in the UK, he does not advocate a sizeable investment in his home market. “The wrong sectors dominate – like banking and commodities. We, at Schroders, are not big on commodities, despite their recent strong performance. In the long run, the Chinese economy is slowing, reducing demand.” He adds that there is an oversupply of certain commodities, energy in particular, which dampens prices. “The oil price is structurally fixed between $50 and $70 a barrel. If the price falls below $50, supply falls as the shale producers drop off; if the price rises above $70 they flood the market.”

More attractive, he says is the EU which is larger and more diversified than the UK and where valuations are still reasonably attractive.

Beyond the EU, emerging markets are an essential component of any portfolio, he says. “We believe the Chinese and US governments will sign a trade deal and avert a full-blown trade war. In this scenario, emerging markets will rally and should produce the best long term returns.” 

Unsurprisingly he does not advocate investing in emerging markets via an index tracker. (Let it be noted that Schroders is an active manager, with no index funds in its portfolio.)

“If you are talking about large-cap stocks in the US, there is nothing to beat an index tracker,” he says. “It is very difficult to beat the market. But when it comes to emerging markets there can be ridiculously big discrepancies between the performance of the fund and that of the market. In this environment, active managers consistently outperform tracking funds.”