European Stocks Could Slide 20% If Populism Spreads, MSCI Says

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European equities could lose almost a fifth of their value if the influence of anti-establishment political parties spreads throughout Europe and the U.S. in the next two years, MSCI Inc. said in an assessment of possible risk scenarios.

The MSCI All Country Europe Index could slide as much as 19.5 percent if populist policies gain enough influence in Europe and the U.S. to reduce trade and increase government borrowing without a corresponding rise in revenue between now and 2018, the firm said. Speaking in its role not as an index compiler but as a consultant on systemic portfolio risk, MSCI cited results of a stress test it carried out on hypothetical multi-asset portfolios.

Central to MSCI’s forecast is the idea that the spread of populist sentiment is likely to take a big bite out of economic growth, an assumption it says is based on a survey of academic studies that point to “stagflation, a portmanteau of low economic growth (driven by restrictions on trade) and inflation spurred by excessive public borrowing,” according to a note. The 20 percent projection embeds an expectation that GDP growth in the U.S. and Europe would be reduced by 3 percent and inflation rise by 3 percent should the policies it’s highlighting gain momentum.

Anti-establishment pressures are on the rise around the world amid stagnating incomes and unemployment. Britons voted last month to leave the European Union, a move that briefly sent global stocks tumbling, while Donald Trump is the presumptive Republican presidential nominee in the U.S. Stocks stand to lose the most among asset classes should populist movements gain ground, with European financial firms among the most vulnerable, said Remy Briand, MSCI’s global head of research.

“Clearly the equity component is much more sensitive to GDP growth than fixed income,” Briand said by phone from New York. “When you have a scenario which reduces growth, you have a proportionally higher impact on equity markets. In a number of the periphery countries, a high share of votes go to populist parties and in general, we have more sensitivity to risk there.”

Stocks in Europe’s periphery would face the largest declines in the euro area, Briand said, as they have historically suffered the most in times of market turmoil. Equities in Greece, Italy and Spain tumbled the most in the world on the day of the U.K. referendum results, as investors fled what are perceived to be the region’s riskier markets. Shares in those countries would prove the biggest victims to a rise in populist policies, followed by those in Ireland and Portugal, according to the test.

MSCI’s study comes amid a full calendar for European elections over the next 18 months. France votes next April, with the far-right National Front expected to make a strong showing. The Dutch will vote by March, and Germany’s federal elections are due late 2017. In addition, Italy will hold a referendum this fall on overhauling its political system. In November, Republican Donald Trump will face Democrat Hillary Clinton in the U.S. presidential election.

Warnings of dire consequences for financial markets were widely circulated prior to the Brexit decision and looked prescient in the days after the shock vote, when equities in Europe plunged more than 10 percent. The weeks since have clouded that verdict, with shares in the U.S. and around the world erasing losses. European shares resumed an advance Thursday on optimism central banks will step up stimulus to limit the fallout from Brexit, though they remain below their level on the day of the referendum.

In MSCI’s stress-test scenario, the firm forecasts a slide of almost 16 percent in the MSCI All Country World Index, versus a 4.6 percent drop for a diversified fixed income portfolio. European financials have about 22 percent of their value at stake, it said.

Globally, industrial firms could outperform, given that anti-establishment movements historically favor spending on defense and infrastructure, the study showed. Growth-sensitive sectors such as small caps and value equities, could each lose more than a fifth of their value.

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