As we pointed out yesterday, according to Deutsche Bank’s Jim Reed who was commenting on the results of last weekend’s Italian election, “it’s hard to get away from the fact that the overall result was another resounding vote for populism. Indeed over 50% of votes submitted was for a populist party, including of course the party with the largest percentage – the Five Star Movement – and a possible kingmaker in subsequent coalition talks – the Northern League.”
Furthermore, as Deutsche Bank’s populism index showed, the percentage of votes for populist parties on a population weighted basis was now around 32% – a level its largely held since the Trump inspired surge in 2016. In fact, you had to go all the way back to the WWII period to find the last time that populism had such support.
A focus just on Europe showed that the continent with the high double-digit youth unemployment has become a hotbed for anti-establishment sentiment, which has everything to do with the economy, and lack of opportunities, and nothing to do with Russian operatives, much to Samantha Power’s chagrin.
Reid’s troubling conclusion is that “it’s hard to get away from the fact that populism is currently going through an explosion in support at present.” Reid also notes that while the above index excludes a vote for Jeremy Corbyn’s Labour party but “one could certainly argue that some of his more radical views and policies are populist in nature.” And if DB were to include Corbyn’s support in the 2017 UK General Election “then our index edges above 35%, eclipsing the 1940s highs, and to the highest since the turn of the 20th century.”
What are the implications:
As of now the rise in populism hasn’t yet destabilised markets however we find it difficult to get away from the fact that uncertainty levels are bound to remain high while such power brokers remain in major elections. Indeed the unpredictability of Trump’s policies is such an example, with the recent tariff threats which have subsequently escalated market concerns about a trade war being one. At a time when global central banks are moving towards an unprecedented era of tightening and dealing with years of massive asset purchases, risks from rising populist support has the ability to seriously disturb the prevailing equilibrium of the last few years and subsequently markets.
While Reid notes that this is more of a slow burning issue over the next few years, he concedes that populism remains the biggest threat “to the post-1980 globalisation/liberalism world order.”
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One day later, it was Bank of America’s turn to opine on the topic of growing populism, which as chief equity strategist Savita Subramanian writes in a piece titled “From Globalism to looming trade war” is “gaining momentum around the world, exacerbated by mass population displacements and surging income inequality.”
She writes that “concerns over immigration, autonomy and global competition have played a role in political campaigns across the globe.”
In this context, the Trump administration’s latest announcement to levy tariffs on steel and aluminum imports is consistent with anti-globalist shifts seen in this presidency. Since Trump’s inauguration, BofA sumamrizes, the US has also:
- imposed travel restrictions,
- withdrawn from the Paris Agreement on climate change,
- backed out of Trans-Pacific Partnership discussions,
- threatened to exit the North America Free Trade Agreement (NAFTA), and
- imposed tariffs on Canadian paper, imported washing machines and solar panels.
So how did the US go from the paragon of globalization to the instigator of a looming trade war, and what happens next?
The following 12 charts from BofA provide some context.
1. Natural disasters, violence and conflicts have led to a record number of persons being displaced. This has put pressure on other countries to absorb more immigrants, adding to social tensions.
2. Income and wealth inequality continues to rise globally.
3. While President Trump announced temporary tariff exemptions for Canada and Mexico, the implication was that permanent exemptions would be contingent on a successful renegotiation of NAFTA, which just wrapped up its seventh round of negotiations with agreement on just six of the 30 chapters.
4. EU is the US’s single-biggest trading partner. EU officials have called out US steel, bourbon, motorcycles, jeans and various food/agricultural products as likely targets for retaliation.
5. Aside from metal producers, the industries most impacted by the steel and aluminum tariffs appear to be Electric Equipment, Machinery, Miscellaneous Manufacturing and Autos.
6. Since 1983, the S&P 500 has been down following the announcement of a trade action 35% of the time in the first seven days, but just 20% of the time in the first 30 days
7. Large caps tend to outperform small caps following the announcements, but small caps tend to outperform once the tariffs are enacted. And in general, stocks tend to do better than bonds and commodities.
8. Tech has among the highest outperformance rates in the 30 days following the announcement, the implementation and the ending of trade actions. Industrials, Telecom and Materials have the worst track record.
9. Growth-At-a-Reasonable-Price (GARP) and Quality tend to do better, while Value and Growth perform in-line.
10. The S&P 500 derives 30% of its revenues from outside the US vs. 21% for the Russell 2000 small cap index. This explains the recent outperformance of small caps and further supports our tactically bullish view on small caps over large caps.
11. Tech has the highest foreign sales exposure and a globally integrated supply chain, making a trade war a key risk for the sector, particularly if the next round of trade actions are aimed at China.
12. BEA data suggests that imports represent 6% of total operating costs for US private industries. Using that as a proxy, we estimate the impact of a trade war that resulted in a 2% drag on foreign sales growth and a 15% rise in import costs would result in a 6% drag on earnings.
Source: DB, BofA