Peak populism?

Technical analysts often use the magazine cover indicator as a contrarian indicator. When an idea has become so commonplace that it becomes the cover of a major magazine, the public is all-in and it’s time to sell.

The Economist reported on an ad hoc study by Greg Marks and Brent Donnelly at Citigroup using covers from The Economist and did find contrarianism works, even though The Economist is not really a popular mainstream magazine:

Interestingly, their analysis finds that after 180 days only about 53.3% of Economist covers are contrarian; little better than tossing a coin. After 360 days, the signal is a lot more reliable—68.2% are contrarian. Buying the asset if the cover is very bearish results in an 18% return over the following year; shorting the asset when the cover is bullish generates a return of 7.5%.

Now consider the following Time magazine cover and accompanying story on Steve Bannon, who is said to be the man behind the Donald Trump presidential throne.
 

 

There is also this cover from The Economist within the same week.
 

 

Still not convinced? How about this cover from Der Spiegel. You don’t even have to read German to understand the idea.
 

 

It isn’t just me, Helene Meisler raised the same question about magazine covers, which was answered by Liz Ann Sonders at Schwab.
 

 

Here at Humble Student of the Markets, our mission to focus on investing and try to remain apolitical. Like most on Wall Street, we don’t protest political developments, we trade them.

Rather than interpreting these magazine covers as just peak Trump, as he will be POTUS for the next four years, the contrarian message may be “peak populism”. Nate Silver recently wrote an article called “14 versions of Trump’s presidency, from #MAGA to impeachment”, where he laid out a variety of scenarios of how Trump’s presidency might proceed.

I would like to offer some details of how the reversal of peak populism might work. As well, there is a possible trade for contrarian investors who are willing to bet on the “peak populism” theme.

Yes, Minister

Back in the early 80s, the BBC aired a satirical series called Yes, Minister which told the story of a government minister’s struggles against the civil service, and vice versa. New political initiatives that upset the status quo would be met with, “Yes, Minister. But…”

Avner Greif’s paper, The Impact of Administrative Power on Political and Economic Development: Toward Political Economy of Implementation, lays out the importance of a civil service to the modern and western concept of good constitutional government. Here is the abstract:

Why did limited government and ‘constitutionalism’ (the rule of law, constitutional rules, and political representation) evolve in some societies but not others? Guided by history, this paper examines why this evolution reflects dependence on administrators to implement policy choices including those affecting them. Limited government and constitutionalism are manifestations of equilibria in which the administrators have the power to influence choices. The thesis that constitutionalism reflects an equilibrium among the powerful differs from the prevailing one, which asserts that it reflects gains to the weak from constraining the powerful. Analyzing the determinants and implications of administrative power reveals its impact on trajectories of economic development. Distinct administrative-power equilibria have different impacts on the security of the non-elite’s property rights; intra-state and inter-state violence (e.g. civil wars and wars, respectively); policies; entry barriers to new technologies and economic sectors; the nature of political conflicts; and the means to resolve conflicts concerning political rights.

Happily ever after?

This post isn’t just about the unconventional approach of the Trump administration, but how the rise of populism has upset the status quo in developed economies. This is also the story of how new governments with revolutionary ideas fall down in implementation. Just because you won an election doesn’t mean that you will necessarily live happily ever after.

Consider the problems of the myriad of details surrounding the Brexit process, which is another political initiative that upset the status quo. Here is FT Alphaville on the latest UK government Brexit white paper:

The UK government’s white paper on exiting the European Union was published on Thursday. Unfortunately, it doesn’t have much detail — or at least nothing like the sort of detail that might provide a picture of how Britain will actually end 43 years of EU membership, replace the entire body of adopted EU legislation, and re-build a trading regime with its biggest overseas market…

Malcolm Barr, an economist at JP Morgan, is simply aghast:

Resources in many government departments have been focused on the Brexit issue since the referendum result back in June. That should be generating a repository of granular, sector level detail that was available to be drawn on for this publication. As a distillation of the state of knowledge within the UK government six months after the vote, and with the beginnings of a time-compressed negotiation just weeks away, the shallowness of the analysis and absence of detail are matters of great concern, in our view.

There’s no discussion of continued EEA membership, no discussion of Britain’s share of EU liabilities, no list of what new regulatory authorities Britain will need, and no real detail on how migrant flows might work.

Call it what you want. Maybe the civil service is resisting change. On the other hand, the government may not simply be prepared for all the operational details of its political initiatives.

Over on this side of the Atlantic, the implementation of Trump’s travel ban is also instructive of how a neophyte government is learning the ropes of administration. Sure, there were protests, which were to be expected given the radical nature of the announcement. What was more disturbing were the reports of confusion by Homeland Security over the details of the directive, which is a sign that the lack of preparation by the civil service, and the courts upholding the legal challenges, which is a sign that the directive was not well written. These are all indications that the government was unprepared for the nitty-gritty of implementation.

Struggles of the political leadership against the bureaucracy is nothing new. In China, Beijing’s stated goal of re-balancing the economy towards consumer spending and away from credit driven infrastructure growth represents a direct attack on the wealth and power of many Party cadres. That’s one of the reasons behind Xi Jingping’s anti-corruption campaign. He wants to control the bureaucracy and eliminate opposition to the policy goals of economic re-balancing.

Politico featured an insightful interview with James Baker, who served in the Reagan and Bush I administrations, about how to manage the bureaucracy. Much of it is about getting the right management structure in place:

When he reigned in the Washington of the 1980s as its premier backstage power broker, Baker took as his personal motto the saying, “prior preparation prevents poor performance.” Clearly, the Trump White House is not yet delivering on the prior preparation part, a problem that Baker says may well be because Trump comes from decades of running his own company exactly as he wished. “Running a business and running the government are two entirely different functions, quite frankly, and process matters,” says Baker, who tells me he has also given his advice directly to Trump, Tillerson and Trump’s new chief of staff Reince Priebus. And presumably also Vice President Mike Pence, who was seated next to Baker at last night’s Super Bowl in Houston. “Process matters a lot in order to avoid mistakes, controversy.”

Already, he is struck by a White House that he worries is set up for internal conflict, division and miscommunication. “The White House that they have constructed has a lot of chiefs,” he says. “In this White House, it seems to me, you’ve got at least four, maybe five, different power centers, so we are just going to have to wait and see how it works in practice.”

Baker believes that you have to understand the process of governing involves dotting the i’s and dotting the t’s. That is a lesson that the neophyte Trump administration, which is mainly composed of outsider, is still learning.

Jim Baker was so invaluable to the Reagan Revolution not because he helped the Gipper blow up Washington but because he knew how to work its institutions. And that included first and foremost the White House, where Baker as chief of staff quickly figured out how to gain control despite being a newcomer to the president’s inner circle who was viewed suspiciously by Reagan’s longtime aides and ideologists like Ed Meese.

In our conversation, Baker makes a point of drawing a distinction between Trump and Reagan on just this point.

“In fact, Ronald Reagan’s administration had a lot of people in it who had been there before,” he says. “And we knew how Washington worked and what didn’t work. Consultation and not surprising people is important if you want them to support the policy and Ronald Reagan was very good at understanding that. He was ideological, there’s no doubt about it… but in terms of how you got there and what you did, he wanted to do it in a way that made it work, so that you could accomplish it. And that’s what he did,” Baker says. “He was to some extent an ideologue but people don’t appreciate the extent to which he was really pragmatic. If he told me once he told me a thousand times sitting there in the Oval Office with him… he would say, ‘Jim, I’d rather get 80 percent of what I want than go over a cliff with my flag flying.’”

Big Bold Ideas are great, especially if you have the political mandate. It’s perfectly ok to want to implement political initiatives, such as “keep the country safe from terrorists”, “leave the European Union and chart our own course”, or “re-balance the economy to a more sustainable growth path”. What is not acceptable a government fumbling their implementation of a Big Bold Idea. Repeat those mistakes enough times, and you will lose credibility and result in the slow death of your populist movement.

Buy the French panic

If you believe that the populism is at or near its high tide mark, a trading opportunity can be found in Europe. In France, support for the socially and fiscally conservative presidential candidate François Fillon is slipping quickly in light of “Penelopegate”, where Fillon put his wife and children on the government payroll without any apparent work performed. The spread between French OAT and German 10-year Bunds are blowing out. This presents an opportunity for contrarians to buy the “French panic”.
 

 

Fillon’s failings leaves a clear shot for upstart centrist Emmanuel Macron, who appears to have the best shot to win the election against Marine Le Pen, the populist anti-establishment candidate. Macron was a minister in the Hollande’s socialist government, but as this Guardian profile shows, he’s not very “socialist” at all. He is best characterized as a left-winger in the Tony Blair centrist mold.

He says he is “of the left”, but keen to unite people from across the spectrum, including the right. Economically liberal and pro-business, Macron was tasked by Hollande with opening up France’s sclerotic economy; the loi Macron reforms that bear his name were so unpopular they had to be forced through by decree. But he is also fiercely progressive on social issues – eager to stimulate growth and free up business while protecting the country’s strong social safety net.

The latest polling averages show that Marine Le Pen ahead in the first round, but Macron would beat her 64-36 in the second round (via Macro Monitor). Moreover, he outperforms all of the other candidates. If Macron were to win, he would go to the Elysée Palace without Fillon`s Moscow friendly tilt. A Macron victory would be bullish for French and European assets.
 

 

For investors who want to play the contrarian “peak populism” trade, buy French OATs. In the alternative, there is also the long France/short Germany equity ETF pair.