Global shift towards populism
After Trump shock, Old Mutual has advice for turbulent political times
KEEP CALM: Peter Brooke, manager of the Old Mutual Flexible Fund at Old Mutual Investment Group investment universe.
Three major surprises in the past year have caused significant market volatility: first came the surprise announcement in December last year that Nhlanhla Nene had been fired as finance minister, to be replaced by Des van Rooyen; next was the surprise outcome of the UK referendum on leaving the EU, Brexit; and just this week and contrary to most predictions, the election of Donald Trump as the 45th president of the US.
“Most of these political surprises have come out of the blue, with the Trump victory being the most extraordinary,” says Peter Brooke, manager of the Old Mutual Flexible Fund at Old Mutual Investment Group. “Despite being written off in the Republican primaries, and the top forecaster giving Trump only a 29% probability of winning the day before, he delivered a clean sweep, which highlights the very strong desire for change and the inability of the elite to gauge the political climate.”
In the run-up to the US presidential election, stock markets reached levels of volatility last seen during the Brexit referendum.
“Hillary Clinton was always the favourite from a financial market perspective as she represented the status quo — and markets like that certainty,” says Brooke.
“Trump, however, represented uncertainty given that his policies are less certain. We are not surprised by weaker markets now that he has won.”
Brooke says that when there is a binary outcome, markets react extremely sensitively as the event gets closer. “Markets don’t like uncertainty and the more polls revealed that Trump could potentially win the presidency, the more sensitivity they displayed.”
Given the size and significance of the US economy, it’s perhaps not surprising that there has been an enormous focus on the US presidential election in the run-up to November 8 and in its aftermath.
The US represents almost 25% of global GDP and what happens in its economy has a ripple effect on the global economy. In addition, the US represents a significant share of global financial markets with the dollar considered a global reserve currency.
The increased impact of politics on financial markets has been a recurring theme and a global phenomenon since the financial crisis of 2008, says Brooke.
“It stems from long-term low global growth which has put both consumers and investors under pressure. Bad political decisionmaking tends to exacerbate low levels of growth.”
Centrist politicians all around the world, he adds, are losing ground while populists are gaining on both the left and right. “We believe this is a lagged impact of the global financial crisis which has resulted in very low global growth and rising inequality as central bank stimulus has helped the rich. The long-term effects of technology and globalisation have also exacerbated the problem, by hurting the income of workers.”
Voters, he says, are not necessarily making obvious choices when voting and are increasingly driven by emotion rather than reason. This means that despite popular predictions and numerous polls pointing towards a Clinton triumph, a populist always had a genuine chance of winning the US elections.
Analysts have long predicted that a Trump win would create some turbulence in financial markets with a drop in the S&P 500 share index. Brooke predicts that the world will now pull back from globalisation and become more isolationist — which doesn’t augur well for global trade or emerging markets, the latter because they are leveraged for trade.
“This in turn hampers global growth with the result that the world remains trapped in a purgatory of low growth, low rates and low returns,” he says.
He also expects a shift to a more stimulative fiscal policy as monetary policy pushes on its limits of effectiveness. “This is good news for growth but less so for global bonds, where we remain underweight.”
What remains in question, he says, is whether central banks will come under attack and money printing converts into inflation.
Although uncertainty around policy direction will negatively impact financial markets in the short term, Brooke says investors need to remember that a lot of the impact will be fairly localised. Healthcare will recover as the Clinton threat abates and US industrials will benefit from fiscal stimulus. The impact of policy may also be muted by the natural checks and balances such as an independent Federal Reserve.
Investors, he says, should not panic. “Brexit taught us that buying shares in the initial sell-off is a good strategy, as the market initially overreacts. It also taught the investment community not to believe forecasts and hence markets were weak into the US election as risk was taken off. Secondly, uncertainty reduces the risk of much higher interest rates as central banks will be cautious about hiking too quickly. This ensures there is still ample liquidity.”
Brooke points to another important lesson revealed by the US election results: unintended consequences.
“As political uncertainty grows in the developed world it makes emerging markets look less bad on a relative basis,” he points out. “With the gold price rising and the oil price falling, South Africa has actually received a small boost.”
However, just because the US election is over does not mean global financial market volatility will be laid to rest any time soon. The trend of populist politicians gaining ground globally has not yet run its course, says Brooke.
“We expect continued political uncertainty, moving to Europe as they start their calendar of elections.
“The next threat will be the demise of the EU due to the rise of populist views. The eurozone has a massive impact on the global trade market and any threat to this region will have far-reaching financial market consequences.”
Locally, our own political soap opera continues to have a major impact on financial markets. Political shenanigans have seen significant value wiped off the JSE and eroded the value of the rand. The ensuing vicious circle of political and economic uncertainty means South Africa is less able to attract foreign investment, which in turn means the country is unable to grow its economy.
The situation is exacerbated by a lack of local investment — lower confidence is resulting in homegrown corporates investing overseas. Lower growth makes the likelihood of a ratings downgrade before the end of the year that much greater.
But, as Brooke points out, a oneoff downgrade is not as much of an issue as the potential threat of multiple downgrades. “Brazilian financial markets, as an example, have weathered their downgrade reasonably well. In South Africa much of the pain of a downgrade has already been priced into the markets. What has not been priced in is the risk of serial downgrades, which could have catastrophic long-term consequences for the local economy.”
To weather political uncertainty, Brooke’s advice to investors is to look through the noise and focus on allocating capital to deliver a decent real return. “In the past 18 months we have held higher levels in cash reflecting our more cautious expected returns,” he says. “South African interest rates are likely to be pushed lower and we are investing this cash.”
As an example, he says buying listed property in South Africa will yield 7.5%, which is similar to cash. However, these yields will grow in the long term, delivering a higher real return. Gold remains an attractive option longer term, he maintains. “In a higher risk environment, gold tends to look more attractive and at least 1% or 2% of any diversified portfolio should consist of gold shares,” he says. “Maintaining a welldiversified portfolio and taking a longer-term view will ensure we navigate these turbulent times.”