A political threat that US investors rarely confront is now a force to be reckoned with - and JPMorgan warns it's powerful enough to tank the global economy
- US investors are grappling with the nascent rise of populism and policy proposals that could reverse pro-growth programs that are in place.
- According to JPMorgan, populism is a paradigm shift that is powerful enough to shape markets for years to come.
- We spoke to John Normand, JPMorgan's head of cross-asset fundamental strategy, about the risk scenarios in the US, and how investors can prepare for what happens next.
- Visit Business Insider's homepage for more stories.
Socialism, in the variety of ways it's understood, has recently become a staple of the US political cycle.
It's spread from the political arena into investing and economics commentary, thanks to policies like universal basic income and free college tuition. Once considered largely unworkable, they're now mainstream campaign platforms.
Proposals like these are byproducts of the rise of populism - an approach that discards traditional policies for largely untested ones - from the margins to the epicenter of developed nations. And according to JPMorgan, populism is not just a partisan political issue. To them, it's a nascent, market-moving paradigm shift that US investors should be aware of and ready to position their portfolios for.
So far, various populist shocks - from President Donald Trump's election to Britain's vote to leave the European Union - have had short-lived effects on financial markets.
That's partly because populist leaders across the world have not fully acted the campaign promises that are considered the most damaging, according to John Normand, JPMorgan's head of cross-asset fundamental strategy.
There have been exceptions, of course. Notably, domestic stocks in Greece and Italy have not recovered all the losses they suffered during politically induced sell-offs in 2015 and 2018, respectively. And in the US, the saving grace of the trade war with China has been the boost to consumption that stemmed from tax cuts.
Going forward, investors may not be so fortunate, and should not assume that the next crop of populist leaders won't fully enact policies that would hurt growth and portfolios.
"The risk scenario is that the next group of populist leaders who might be running a government at some point in the next couple of years recognizes the negative consequences of their policies much later than current populist leaders have, " Normand told Business Insider.
He continued: "By the time they do, economies and markets would be much weaker than the damage witnessed over the past few years."
One source of weakness lies in the monetary and fiscal-policy toolkit that's available to combat the next downturn, Normand said. When the global economy enters its next crisis, there will be less scope to cut interest rates because they were lowered to historical depths after the Great Recession. There's also reduced scope to enact fiscal policy because government-debt levels are already so high.
These conditions, in turn, could make easier for the electorate to rationalize populist policies that may be detrimental to growth.
The US is at more risk of this scenario - even more than Europe - as the 2020 elections draw near, Normand said.
"There seem to be to higher odds of unorthodox policies in the US, if Democrats sweep 2020 elections or if Republicans control the White House and Congress again, because both sides of the political spectrum are more extreme than usual," he said.
He continued: "That's why US elections are a more material risk for markets than those for the EU Parliament. The EU Parliament doesn't have much authority, so populist control matters less."
With the risks in mind, how should investors be hedging their portfolios for an anti-growth outcome? It's still too soon to actually do so, Normand said. After all, the elections are still 19 months away, there will be many other market movers in the interim, and the Federal Reserve's pause on interest rates could juice the economy for longer.
Still, there are a few important things to keep in mind.
The "fundamental risk," Normand said, is a Democrat sweep that paves the way for left-of-center policies including a reversal of Trump's tax cuts, a wealth tax, and a possible advancement of his trade agenda.
In his view, US assets are unprepared for such a scenario whether you look at stock price-to-earnings ratios trading close to their long-term averages (so not cheaply), or investors' preference for owning the dollar over defensive assets like the yen and gold.
"If we are correct on both the economy's 2019 growth path and the 2020 risk scenarios, higher valuations and more skewed positions will render underweights in US assets more compelling a year from now," Normand said in a research note.