Regardless of who wins Tuesday, the political storm is just getting started

Citigroup says populist political storm is brewing

Tuesday's presidential election will produce both a winner and a loser, along with a longer-lasting political effect: A rise in populist fervor that is unlikely to abate.

Donald Trump and Vermont Sen. Bernie Sanders ran on opposite sides of the populist fence, one a billionaire businessman trying to get government off people's backs and the other a renegade democratic socialist looking to rid the system of big money's corrupting influence.

Sanders' quixotic run came up just short, and Trump's may as well, if current polls are accurate. But the grassroots ire that fueled them won't die out anytime soon.

Vox populi, or the voice of the people, is the phrase Citigroup analysts pick to describe what they feel will be a powerful force ahead both domestically and globally, one for which many investors have not developed a sufficient appreciation.

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"The important thing for investors is that political risk is not just rising, it is changing," Citi said in a report for clients. "The new style of vox populi risk emerging in advanced economies is beginning to undermine the political capital of administrations and to impact policy. This is a new political risk that potentially has a very direct and in many cases, immediate impact on the economic and market outlook."

From Citi's standpoint, it means uncertainty that will stunt growth and make stocks riskier investments. The firm expects U.S. government bond yields — the benchmark 10-year note in particular — to rise, while emerging market stocks will benefit.

More clouds for the market

"There are many policy areas in which the shifting political sands could impact the global economy: world trade under rising protectionism or a shift away from monetary to fiscal policy against a backdrop of spiraling debt, are just a couple," Citi said. "Whatever the outcome of Tuesday's vote, the policy backdrop is unlikely to get much easier any time soon, and policy impasse is seldom good for confidence or growth."

In a separate report, Citi's chief global political analyst Tina Fordham said a byproduct of the populism has been a general mistrust of institutions, and that will contribute to a difficult environment.

Issues such as low trust in institutions, bipartisanship, identity politics and demographic divides will continue to fuel political risk in the U.S.
Tina Fordham
Citigroup chief global political analyst

"The tenor of this campaign and heightened polarization does not bode well for governance, regardless of who wins the election," she said. "Issues such as low trust in institutions, bipartisanship, identity politics and demographic divides will continue to fuel political risk in the U.S."

It's been a peculiar year for the market, with stocks swooning at the beginning, rallying into July and trading in a tight but volatile range since. In total, the is up more than 4 percent year to date, with a strong boost from Monday's rally, which seemed to take its inspiration from an announcement that the FBI would not be charging Hillary Clinton over her email use while secretary of state.

While the news cast a balm on Wall Street, more clouds could be on the horizon.

Forget the looming Fed rate hike for a moment; one imminent danger is that Trump may not go away even if Tuesday's results show him losing.

"Trump may dispute a Clinton win and challenge the result, which could prolong uncertainty. Whatever the cause of uncertainty, it tends to have a detrimental impact on economic growth," Jeremy Hale, Citi's head of global macro strategy and global asset allocation, said in a note. "This would surely materially raise the risk of a global growth recession.

Wars within the parties

To be sure, the tumult could work in the market's favor.

Should Clinton be elected president, she may well have to fend off a populist revolt from within her own party that would be led by Sanders and Massachusetts Sen. Elizabeth Warren. And Clinton's plans to implement tax hikes for higher earners and a transaction tax on Wall Street would find stiff opposition from congressional Republicans.

What it could generate ultimately is an environment where not much of anything gets done.

"Investors appreciate the likely gridlock that's going to prevail. For a lot of Americans it's frustrating, but for the markets, gridlock means they do less harm," said Greg Valliere, chief global strategist at Horizon Investments and an expert in the Wall Street-Washington nexus.

The immediate post-election aftermath will result in a "civil war" among Republicans and "similar fissures" opening up on the Democratic side, he said.

"I have a hard time believing we're going to get populist unity. The populism of Bernie Sanders is a hell of a lot different than Donald Trump's," Valliere said. "It's out there as a factor. But the overriding difference is that the economy is clearly showing signs of accelerating, and an improving economy would weaken some of that populist fervor."