THIS ISSUE 

 

From the Desk of

GARRETT D’ALESSANDRO, CFA, CAIA, AIF®

The American presidential election and the Brexit vote in the United Kingdom (UK) demonstrated the beliefs of millions of citizens in both countries that their governments were dominated by elites who were not attending to the interests of ordinary people. This view, generally known as populism, is driving policy in directions that are important for investors to understand.

As investment managers, it’s vital for us to reflect on and understand the economic and social impacts of populism and its policy ramifications, regardless of one’s political views. Consequently, we are studying the economic impact of government policies and the resultant distribution of incomes, wealth, and mobility for U.S. citizens.

The chart below illustrates how the U.S. and UK have performed in developing equal opportunity and/or equal wealth/incomes across the population. The fact that the U.S. and UK have the highest inequality and/or the least upward mobility helps explain what has driven the appeal of populism and populist candidates in both countries.

social-vs-income-mobility

Focusing on the U.S., the data shows that, compared to other developed nations, our society has become less balanced in terms of the distribution of income and wealth and less able to offer equal opportunities to all Americans. While there are several reasons for this, the belief that the elites in positions of power throughout U.S. society have worked against the interests of the population as a whole is the essence of the populist appeal.

However, there are other factors at work. It’s true that the amount of U.S. GDP earned by workers has declined from 48% to 44% over the past three decades – a significant decrease. But globalization, which enabled businesses to shift jobs (and therefore wages) overseas, and technological advancements (automation, robots, etc.), which diminished the overall need for employees, played substantial roles in the declining share of GDP flowing to workers. In other words, the issues fueling the rise of populism cannot all be blamed on the elites.

In thinking about how well citizens in developed countries have fared, it’s important to note that there is a fundamental distinction between creating equal opportunity for all citizens and creating equal outcomes. The U.S. was founded on the premise – and promise – of equal opportunity, while Europe as a whole has preferred the ideal of equal outcomes. In some ways, the average European household has been taken care of better by its governing institutions. However, this comes with a trade-off.

Most European economies have become less favorable to business relating to global competitiveness and growth rates of real per capital incomes. Each country thinks about the kind of society it wants and then pursues those policies best suited to achieve that society. Adopting the populist concept of equality of opportunity would fundamentally align with the premise upon which the U.S. was founded.

Again, we are not taking a political view here. Our focus is on the data and the trends we project, the governmental policies that may be enacted, understanding how those policies could impact social, economic, and financial conditions, and making investment decisions according to the interests of our clients. In that context, here are some of the investment-related issues we are considering:

  • Will the policymakers in Washington produce truly beneficial policies that address the major concerns of all Americans, or will there be no real change in terms of social mobility and economic well-being?
  • How will these policies specifically benefit Americans – through better opportunities or through better outcomes?
  • How much of each policy should be focused on economic affordability while preserving the well-being of all Americans?

While the process of developing these initiatives is unfolding, it’s clear who needs to benefit from the policies that will be enacted – middle-class citizens. Identifying and enacting healthcare and tax reform policies requires that compromises be accepted to bring about a more competitive U.S. worker and a more competitive U.S. economy.

Economic research has shown that areas best suited to creating long-term changes in productivity and competitiveness include improving education and creating job training programs, which are superior to short-term policies such as tax cuts for the wealthy or erecting trade barriers for uncompetitive industries. However, economists now agree that trade policies should measure their full impact and seek a better balance between profit maximization and social impact.

Current areas of legislation being considered include regulatory reforms, healthcare reforms, and tax policies. If Americans want a country that makes the lives of all citizens better, these new policies should have as a principal objective achieving a balance of offering better opportunities and better outcomes for middle-class workers.

All Americans – and the rest of the world – will be watching to see whether the new administration and Washington as a whole can bring about changes that make the lives of middle-class Americans better.

Important Disclosures

The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell, any of the securities mentioned herein.

Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources, and, although believed to be reliable, it has not been independently verified, and its accuracy or completeness cannot be guaranteed.

Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this document and are subject to change.

There are inherent risks with equity investing. These risks include, but are not limited to, stock market, manager, or investment style. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. Investing in international markets carries risks such as currency fluctuation, regulatory risks, and economic and political instability. Emerging markets involve heightened risks related to the same factors, as well as increased volatility, lower trading volume, and less liquidity. Emerging markets can have greater custodial and operational risks and less developed legal and accounting systems than developed markets.

Concentrating assets in the real estate sector or REITs may disproportionately subject a portfolio to the risks of that industry, including the loss of value because of adverse developments affecting the real estate industry and real property values. Investments in REITs may be subject to increased price volatility and liquidity risk; concentration risk is high.

Investments in Master Limited Partnerships (MLP) are susceptible to concentration risk, illiquidity, exposure to potential volatility, tax reporting complexity, fiscal policy, and market risk. Investors in MLPs are subject to increased tax reporting requirements. MLP investors typically receive a complicated schedule K-1 form rather than Form 1099. MLPs may not be appropriate investments for tax-advantaged accounts because of potential negative tax consequences (Unrelated Business Income Tax).

There are inherent risks with fixed income investing. These risks may include interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond. When interest rates rise, bond prices fall. This risk is heightened with investments in longer-duration fixed income securities and during periods when prevailing interest rates are low or negative. The yields and market values of municipal securities may be more affected by changes in tax rates and policies than similar income-bearing taxable securities. Certain investors’ incomes may be subject to the Federal Alternative Minimum Tax (AMT), and taxable gains are also possible. Investments in below-investment-grade debt securities, which are usually called “high yield” or “junk bonds,” are typically in weaker financial health and such securities can be harder to value and sell and their prices can be more volatile than more highly rated securities. While these securities generally have higher rates of interest, they also involve greater risk of default than do securities of a higher-quality rating.

Investments in emerging market bonds may be substantially more volatile, and substantially less liquid, than the bonds of governments, government agencies, and government-owned corporations located in more developed foreign markets. Emerging market bonds can have greater custodial and operational risks, and less developed legal and accounting systems than developed markets.

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Index Definitions

The Standard & Poor’s (S&P) 500 Index represents 500 large U.S. companies. The comparative market index is not directly investable and is not adjusted to reflect expenses that the SEC requires to be reflected in the fund’s performance.

Indices are unmanaged, and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.