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Brian Andrew, CFA

Raison d’etre

Yesterday’s French primary election left global investors feeling better about the future. The two lead vote getters, Marine Le Pen and Emmanuel Macron, will run-off against one another on May 7. Because they represented the “expected” outcome, markets are unwinding their reduction in risk. As a result, stocks are rallying around the globe and bonds are selling off at the margin. The euro currency is strengthening against other developed currencies like the U.S. dollar and the Japanese yen. Why should we care? Because our raison d’etre is understanding how these geopolitical events may affect the asset allocation decisions made on behalf of our clients.

Secular & Cyclical Forces

 
One of the tenets of our investment process is understanding how both secular and cyclical events may effect asset prices. Cyclical events refer to those fundamental factors such as economic growth, unemployment and corporate earnings growth that change with the business cycle. These cycles last years. Secular events refer to changes that may take decades to play out, such as a demographic shift between generations and its effect on a political system or the economy.

Last week, we wrote about the importance of following geopolitical events and their impact on markets. Today, the outcome of the French primary provides additional insight into the election’s effect on secular and cyclical forces.

From a secular perspective, the two primary winners, Macron and Le Pen, represent the electorate’s dichotomy that exists due to a demographic shift, a secular phenomenon. It also represents the more sanguine feeling about improvement in the business cycle, due to the improvement in the French economy and unemployment. Le Pen is a candidate who suggests that France should exit the European Union and “close its borders” to immigrants from North Africa. Macron is a young (39) centrist socialist candidate who favors remaining in the European Union and encouraging a “friendlier business environment” in France.

Neither of these candidates represents the establishment political parties in France. This is not dissimilar to the popularity of Donald Trump and Bernie Sanders in the United States. It could be said that they, too, did not represent the establishment. In addition, the two lead vote getters in the French primary also represent very different perspectives on how France should move forward, just as Trump and Sanders did here.

It is possible that the rise of non-establishment candidates’ popularity stems from the concerns of an aging labor force. In the U.S. we refer to them as Baby Boomers. Around the developed world, there is a large portion of the labor force that is reaching retirement age during a period of extremely low economic growth. In fact, the low growth may be due to the declining demand that comes from this aging population (in emerging markets where the work force is much younger, growth rates are higher).

Central bankers recognize this low growth and have taken never-before-seen measures to try to stimulate it, namely lowering interest rates to 0% or near 0%, and purchasing trillions of dollars of debt securities. Low interest rates make it difficult for this older work force to earn income on their savings. In addition, the cost of social programs that are intended to assist this older working group as they retire is now being called into question. Because developed economies, including the U.S. and those in central Europe, have benefitted from the last several decades of globalization (identification of cheaper labor and new markets for products and services), the structure of labor markets has changed. Add to that the internet technology that makes global logistics and information sharing possible, and it is easy to see why we have a disaffected older working population in Europe and the United States.

These secular forces cannot be dealt with in short order. The rise of populist candidates like Trump and Le Pen are a reflection of some voters’ angst regarding the future of their economies. Those who feel that they are disadvantaged by globalization, slow economic growth and low interest rates are raising their voices at the ballot box. In Europe, the U.K.’s vote last summer to exit the European Union and the fact that a nationalist like Le Pen was the second highest vote getter reflect this dissonance.

In the U.S. we will continue to see a generational battle between the Boomers and the younger Gen X’ers and Millennials. Because these younger people represent a group larger than the Boomers, we will likely see a meaningful improvement in economic growth as they age. Europe, however, lacks this younger generation in numbers, so many in the ruling parties view immigration as the way forward. Of course those who have been disaffected by globalization have concerns about that. Also, those who would use this influx of people from North Africa to place terror in Europe see this time as an opportunity.

Portfolio Construction

 
The heightened sensitivity of markets to geopolitical events like elections requires investors to consider their portfolio positioning with respect to global markets. We use international and emerging market stocks and bonds in portfolios and consider how events impact those investments. As an example, we know that emerging Asian markets are growing faster than those in Europe and the U.S., so we can identify managers who buy established companies in Europe benefitting from Asian trade. The election outcome in France may dictate future policies toward businesses engaged in that trade.

We also focus on risk management. Understanding our exposures to foreign investments and how the managers we use hedge their currency and credit exposure is another way we pay attention to how secular and cyclical events may impact our portfolios.

We want to consider how these secular and cyclical forces affect our current investments and also where they might provide new opportunity. As an example, as Asian markets grow, infrastructure investing has risen. It may also rise here in the U.S. due to government policy. Considering how this increased spending might affect commodity markets and which companies benefit most from it will impact our allocation.

The demographic shift described in this commentary presents a number of investment opportunities and risks that we regularly consider. For example, we know aging global populations will produce increased spending in healthcare. Considering the impact on providers, pharmaceutical and biotech companies–which of our managers has expertise in these areas–is a part of our consideration when allocating capital.

Our raison d’etre is helping our clients achieve successful financial outcomes so they can also achieve their own objectives. Our investment process and research into the impact of global geopolitical events allow us to contemplate how to manage risk and take advantage of changing markets.

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Views and comments expressed in this blog are those of the author and do not necessarily represent the positions of Cleary Gull or fellow Cleary Gull associates.