It’s been said that a butterfly flapping its wings in China can cause a hurricane in Kansas. In a similar way, investment research firm MSCI has suggested that recent political developments may have devastating economic and financial consequences.
The latest edition of the company’s Scenarios, Stress Tests and Strategies
series focuses on the rise of populism in developed countries, positing that it could lead to an economic crisis.
Noting trends from June’s Brexit referendum and the ongoing US presidential campaign, the study observes an increase in populist sentiment. In particular, there are increased assertions of sovereignty or isolationism, calls for barriers to trade and immigration, and appeals for increased deficit spending to support the middle and lower class.
In hindsight, the development of the current political attitude should have been obvious. “Populist movements have appeal when the economic pie is not growing, it is being divided unevenly, and there is a perception that outsiders are competing unfairly for what remains,” the study explains.
And the ingredients have all been there. Growth in major countries around the world has remained stagnant since 2008, along with job insecurity plaguing key European markets; benefits from globalization go mainly to emerging markets and individuals the top 1% of income distribution, possibly causing the disparities observed in income and wealth; and immigration has become a key consideration among voters in the UK and the US.
Looking at the historical impacts of protectionism, the study sees trouble. On the macroeconomic level, there’s stagflation, low economic growth from reduced trade coupled with inflation driven by excessive public borrowing/spending, the risk of which is exacerbated by current low interest rates. On the level of the equity markets, effects are varied, with some sectors taking hits and others outperforming.
Two possible political scenarios are considered in the study. In one case, Brexit would fuel populist sentiment in Europe, leading to the disintegration of the Eurozone. The other case sees populist policies applied in Europe and the US, which could choke trade and bring about government overspending.
Assuming the scenarios actually play out, the proponents see losses for equity, sovereign, and credit debt markets overall, along with growth-sensitive equity strategies and possibly even broadly diversified portfolios.
On the other hand, certain sectors are projected to come out ahead. Industrials may benefit, assuming that spending on defense and infrastructure increases. Defensive equity sectors, fixed-income portfolios with lower duration sovereign debt and credit, and inflation-protected government securities are also expected to perform well relative to market.
Like most scenario-based stress tests, this latest MSCI study bases its conclusions on very specific assumptions. Still, given the pessimistic mood many investors are in at the moment, they may be inclined to give it some serious thought.
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