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Inequality Resurrects Political Risk

| Investment | By Gary Reynolds

“The best lack all conviction, while the worst are full of passionate intensity”
W.B. Yeats (1865 -1939)

I am an extraordinarily disorganised person, which is why I have to surround myself with highly efficient people. Like many that are blighted by more than a few eccentricities, I find myself possessing extreme obsessions, one of which is retaining an archive of all key articles that I read. Karen, my PA, is fastidious at maintaining these archives which are kept under hundreds of different directories, ranging from geographical designations such as ‘USA’ to more obscure subjects such as ‘The Utility of Happiness’.

One archive is headed ‘Politics & Religion’, and within it I keep copies of pieces to which I may want to refer in the future. The chart below shows the number of political articles that I have saved in recent years. In 2009 it was just five, but last year it reached 56, of which 15 were to do with Scotland. This year, I have already saved 67. Political risk is back with a vengeance!

The risks to which I refer are the influence of rapidly growing fringe parties on the left and right of the political spectrum. They have one thing in common, they offer simplistic solutions to a disillusioned electorate. Right-wing parties such as Golden Dawn, UKIP, Marine Le Pen’s Front National, Holland’s PVV, etc, tread a well-worn path of blaming foreigners for depriving their nationals of jobs and benefits, and with some success at the polls.

More recently, left-wing parties and their politicians have found a ground swell of support by promising a “fairer” society which involves the state (politicians) taking control of national assets. Despite these parties brandishing an array of policies that spectacularly failed over the last 50 years, Greece’s left-wing Syriza Party has been re-elected for a second time and Podemos may be part of a controlling left-wing coalition in Spain by the end of the year. At home Jeremy Corbyn has been elected leader of the Labour Party on a ticket of re-nationalisation, demilitarisation and “people’s QE”, which can best be described as the Zimbabwean method of quantitative easing (QE) whereby the state prints money and spends it.

The reason for this resurgence of populist politics is that people are ‘hacked off’, and they have good cause. High jobless numbers and epidemic unemployment among the young people in Southern Europe (unemployment amongst the under 25s is currently over 50% in both Greece and Spain) cause unrest. If you were a 20 year old Greek that could not find work then why wouldn’t you ditch the establishment in favour of the charismatic Alexis Tsipras promising you something better? What have you got to lose? Closer to home, the average working family in the UK has had to tolerate a zero increase in real income for years. As RBS’s Group Economist, Stephen Blackman, told me, cheap food from Tesco and cut-price holidays from EasyJet have done much more to improve the well-being of the average working Brit than any amount of government economic policy./p>

Feelings of inequality are enhanced by US and Bank of England style QE which, quite deliberately, pushes up the value of assets so that the ‘wealth effect’ (people feeling better off) increases, or maintains, demand that would otherwise be falling. The bi-product is that the wealthy get wealthier and the bankers do quite well too. In his Sunday Times article of 26th July 2015, economic correspondent Irwin Stelzer pointed out that JP Morgan’s Jamie Dimon and Goldman Sachs’ Lloyd Blankfein were both now billionaires, despite their respective organisations needing a tax payer bail-out following the global financial crisis. That is just plain wrong, even for a free-market capitalist like me.

The good news for those of you concerned by the fact that the leader of the main opposition in the UK, and potential future Prime Minister, seems much more comfortable singing The Red Flag than God Save the Queen, is that this type of populism tends to die out. Nonetheless, it does increase the risk that, in the event of a slip-up by a more moderate government, a quite radical opposition may be elected; there are ample examples of this over the last century and a more recent one in Greece.

Clients pay us to worry about risks and structure their portfolios accordingly. Political risk tends to be localised (ie., specific to the market in which the damaging policies are introduced) so global diversification helps to reduce this. Bonds and currency tend to suffer badly under errant, spendthrift governments, so keeping bond duration short, and diversifying across currencies, also helps to reduce the effects of a political catastrophe. We started reducing bond durations, and holding more overseas currency (particularly the dollar), a while back. There are reasons for doing this even if a reincarnation of Che Guevara is not elected as Britain’s next PM. In particular, the UK is running a very big current account deficit, which I will cover in a forthcoming article and almost certainly during our client seminars in December. I hope you will be attending; 2015 is providing a wealth of juicy material for us to cover.

Gary Reynolds CFA

Chief Investment Officer

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