OCTOBER 2016

The Rise of Nationalism: Causes and Investment Implications

Category: Investment Research

By Jeff Egizi, CFA, Senior Research Associatejeff-egizi_220x190

Nationalist and populist political ideologies are moving into the mainstream in the United States and much of Europe.  Candidates who back these ideologies have opportunities to perform well in elections/referendums in the US, Italy, France, Austria, and Germany over the next 15 months.  Why did this rise of nationalism occur, and what are the potential consequences for markets?

Multinational corporations have benefitted significantly from increased global integration and the resultant rise in cross-border trade over the past 25 years.  Meanwhile, the middle classes in developed markets such as the United States and the United Kingdom have seen their relative standards of living deteriorate during this period.  Candidates such as Donald Trump are successfully exploiting this issue through promises to implement protectionist policies, such as tariffs on trade with China and Mexico, repealing the Trans Pacific Partnership (TPP), and threatening to back out of the North American Free Trade Agreement (NAFTA), all in an attempt to bring lost jobs and wages back onshore.

Anti-immigration sentiment has also cropped up alongside this anti-globalization sentiment, furthered by terrorist attacks and the refugee crisis in the Middle East and Europe.  Similar themes were evident in the United Kingdom ahead of their “Brexit” vote in June, and may reappear in upcoming votes in Italy, Austria, Germany, and France.

Thus far, Wall Street and Main Street have been able to shrug off the momentum in nationalist politics.  Markets breathed a sigh of relief following the UK’s Brexit vote, as initial losses were quickly reversed and the S&P 500 jumped to new all-time highs, in part thanks to the supportive response by central banks.  Economic data in the UK has also beaten expectations following the vote, while implied equity volatility remains near cycle lows.  To some, this suggests the market will once again climb the “wall of worry.”

A more cynical interpretation is that the benign reaction to Brexit only served to bring nationalist politics further into the mainstream ahead of more consequential votes in the months ahead.  The politicians and voters supporting these views will be emboldened by the lack of collateral damage.  However, an Italian exit from the euro or Trump’s trade agenda have more potential to harm the global economy and financial markets. Italy’s exit from the euro would spur large write-downs for global banks that see their Italian assets redenominated into lira, and Trump’s anti-trade policies, if implemented, would crimp profits for multinationals and emerging markets.

We do not profess to have an edge in forecasting who will win these elections or to what extent these parties will be able to execute on the most extreme aspects of their agendas.  For example, the degree and expediency of Trump’s policy implementation would be influenced by the outcome of Congressional elections, and an unraveling of the Eurozone is still not a base case.  That being said, we are observing investor complacency, reflected in low implied volatility and high asset prices, ahead of events that have the potential to be very disruptive for markets over the next few months.  As a result, we continue to advocate a conservative risk posture; overweight cash and gold and underweight global equities.

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