This combination of political and currency risk is a risk we don’t need to take.
Anthony Rayner is a fund manager on Miton’s multi-asset team
History has many examples of extended periods of economic weakness leading to the popularity of extreme political parties or the introduction of extreme policy. The Great Depression in the 1930s was a context for both the popularity of the Nazi party in Germany and the introduction of the “New Deal” in the US, when Franklin Roosevelt introduced a range of massive programmes aimed at stimulating a US economic recovery.
The current economic situation is not of the scale of the Great Depression, where US unemployment stood at 25% but, since the Great Financial Crisis of 2008, global economic growth has been subdued, despite some fairly extreme monetary policy action. With policy makers and politicians seemingly unable, or unwilling, to find solutions, the electorate has started to challenge the status quo and challenge the validity of those in power.
Of course, it’s not just an economic story, not now and not in the 1930s. Woven into, and compounding, the current economic insecurity is the refugee crisis and a growing fear of terrorism. All of which mainstream politicians are struggling to tackle, while populist politicians are seen to be offering solutions. Added to this dynamic is the growing distrust of what are increasingly seen as the political elite, something which the leaked “Panama papers” do little to question.
This is reflected in recent political history in the Eurozone, which has been characterised by the fragmentation of politics, where the vast majority of the vote is no longer held by the two main traditional centre left and centre right parties. Instead, more radical parties are gaining popularity, suggesting a frustration with the traditional mainstream politics that have dominated the status quo.
The recent state elections in Germany saw the main parties lose material votes to smaller parties, including the anti-immigrant AfD. Spain has still failed to produce a government, despite a general election in December, as populist parties gained at the expense of the two traditional main parties. Similar stories can be seen across the region.
In the UK and the US, fragmentation of the vote is also very evident but is occurring within the existing party structures. For example, the populist figures of Donald Trump and Bernie Saunders sit within the Republican and Democrat parties, doing battle with their mainstream counterparts ahead of the US presidential elections in November. Meanwhile, in the UK, the Labour party’s unity has been seriously threatened by the election of populist left leader Jeremy Corbyn, while the Conservative party is creaking ahead of the June EU referendum, with “Europe” traditionally the lightning rod for party discontent.
So, ironically, at a time when the electorate is looking for strong governments to offer solutions to real challenges, they are faced with high political risk: weak, fragmented and possibly short-lived governments. Financial markets struggle to quantify political risk, specifically the combination of forecasting the outcome and then understanding the impact of that outcome. The usefulness of polls is further undermined by this ‘new political order’, as there are more ‘undecided’ floating voters. More generally, wherever it is in the world, politics entails a lot of horse-trading, often behind closed doors, and this only adds to the lack of transparency.
As a result, political risk is something we look to minimise in the portfolios (for example we recently decided to avoid Brazilian utilities when increasing our Latin American exposure, due to the deterioration in the fiscal situation there). This is compounded as political risk is often expressed, in the first order, via currency markets. This combination of political and currency risk is a risk we don’t need to take.
