There is growing evidence of increasing populism in the world today. We would argue President Donald Trump was elected on both occasions in part due to this anti-politician narrative. Then more recently one of the most recognisable cities and potentially a poster child for capitalism New York elected Democratic Socialist Zohran Mamdani as Mayor. His proposals to freeze rents and raise taxes on the wealthy clearly resonated with New Yorkers. If there is a growing trend of populism, investors should at least have some idea of how financial markets behave in such a regime.
What is populism?
A political approach that strives to appeal to ordinary people who feel that their concerns are disregarded by established elite groups.
Can regime change be identified by investors?
Yes. Government policies have a significant impact on markets and company earnings. Hence, understanding regime changes and seeing turning points in the market dynamics on the back of these changes should inform investors’ asset allocation decisions. In a recent paper, the Man Group researchers provided seven macro-economic variables (provided in figure 1) that could help investors identify a regime change.
The one variable from the list above we would call out is the stock-bond correlation. Investors use bonds as a defensive asset to provide a cushion to portfolios when equities are declining. However, in populist regime, historical data shows that the correlation between stocks and bonds is positive. That is, bonds are unlikely to provide the defensive qualities investors are seeking. Why? Populist policies are inflationary due to aggressive fiscal policies, trade protectionism and accommodative monetary policy. This leads to investors demanding a higher premium (i.e. interest rates) on bonds and markets become increasingly synchronised. A dataset which looked at 219 populist episodes in 60 countries saw stock-bond correlation go from -0.47 to +0.24 during populist regimes.
Market impact.
Allianz Global investors used the same data from Funke, Schularick & Trebesch to see how financial markets behaved during periods when the head of government is a populist. We provide their results below.
Market impact – Bonds.
The results are more mixed for bonds as higher debt levels – driven by aggressive fiscal policies – are likely to keep bond returns muted.
Market impact – Equities.
What’s interesting is that equity returns were strong in the first three years but fall close to zero over 15 years. Allianz paper explains – “We see the underwhelming performance in line with the negative longer-term hit to economic growth. The initial steadiness in equities is consistent with the expansionary fiscal policy pursued by populists and the stable economic growth rate in the first two to three years under a populist government.”
We are constantly watching the macro environment for regime changes to ensure our portfolios are suitably positioned to benefit.
