You could argue concerns over French far-right politician Marine Le Pen winning the French elections in March were overblown, since opinion polls never indicated a win for the National Front.
Then again, Donald Trump was not supposed to become President of the United States and Brexit wasn’t going to happen either.
But they did.
Geopolitical risks such as these are increasingly occupying investors’ minds and the rise of populism is among the key concerns for market stability.
But how do you incorporate geopolitical risks into a coherent investment strategy?
Thomas Clarke, a portfolio manager in William Blair’s Dynamic Allocations Strategies team, says the answer is found in game theory.
“Populism is everyone’s lexicon now; it is mainstream,” Clarke says during a recent trip to Australia.
“The problem is that everyone agrees this is important, but not everyone agrees what to do about it.
“How can you incorporate it into an understanding of the markets and into investment decisions? How does it feature into what is driving exchange rates, other than being something that you have to be scared of?
“The way we try to form our analysis around this thing is we have borrowed from game theory and we see geopolitical scenarios, such as the rise of populism, as game theatres.
“By that I mean it is a multiplayer negotiation exercise: you’ve got several players, leaders, competing constituencies and they have different objectives, different tools as how to advance those. We want to organise that information in a way to extract investment information.”
Clarke, a currency specialist, argues it is not about access to new information, but about rearranging the information you already have to make it more relevant for investment interpretations.
He offers the Brexit referendum as an example of how an event influenced his thinking about the direction of currency values.
“In a game theatre sense, we’ve got two players here: Stay and Leave,” he says.
“They don’t want the same thing, they want the opposite, so they can’t both win. Who is more powerful?
“Before the referendum, the only information you’ve had was opinion polls on who might win. It was about even. You have two equally powerful players who wanted the opposite of each other.
“The novel thing about that was that the two players in the game shared a mutual incentive to deliberately increase risk, to raise the noise level, create uncertainty that otherwise wouldn’t be there.
“They issued threats, warnings and forecasts of bad things happening if they didn’t win. That is the kind of uncertainty that markets hate and run away from.”
The only thing that will see [populism] off in the medium term is a few years of robust, inclusive, strong growth across the world. We are not really getting that yet.
This information is important, he says, because it will help you asses in which direction prices might move.
“Is this something that is going to assist a price moving towards fundamental value – for example, it was expensive and this is a downwards influence – or is it going to get in the way?” he says.
“With the British pound, we thought it was already a fundamentally expensive currency and this was the source of risk that was only going to assist a downwards correction.
“I’ve got now two components in the way I think about things: one is fundamental, which says down, and the second is geopolitical, which says down as well. They are aligned.
“So I’m going to be short the pound and I’m going to be more short, take a more aggressive position, because of geopolitics.”
A similar line of thinking was applied to the influence of a successful attempt at the presidency by Trump on the Mexican currency.
“If you think about Donald Trump becoming the US President and the Mexican peso, it is not a tailwind, it is a headwind,” Clarke notes.
“The currency was fundamentally attractive, but you had a development which would be negative for Mexican growth if it came to fruition, so it made it more risky and less compelling.
“When Trump became President and he tweeted about building a wall and making America great, the peso dropped to an all-time low. Now, it is very attractive.
“Trump is still President, but the avalanche has happened and although it looks messy, the snow has fallen to the bottom of the mountain and the risk you run is lower.
“That is when you can get in. We don’t need to be shy of this [currency] forever.”
Clarke believes the influence of populism on markets will be a force for some time.
“We first incorporated populism as an investment consideration in February 2010 and we were referring to the Tea Party in the US during the first Obama administration,” he says.
“[Since then] it has popped up all over the place.
“Despite [the election outcome in] France, it is still growing in influence and the geopolitical risks and macro risks arriving out of the populist wave are still very, very important and will be for some time to come.
“The only thing that will see that off in the medium term is a few years of robust, inclusive, strong growth across the world. We are not really getting that yet.”