There seem to be two quite distinct camps emerging when it comes to thinking about how the uncertain political environment will shape markets.
One side believes that the shifting political landscape will have (yet to be felt) consequences for the global economy, currencies and asset prices that will dwarf all other considerations. The other believes that it is a somewhat distracting backdrop which will have negligible consequences.
At this point, the latter camp thinks that they are two-nil up and winning the game. I would like to suggest that neither side is entirely right and argue that investors should perhaps be watching a different match altogether.
Are we worrying too much about politics? There is a case to be made that the powerful intersection of non-stop news coverage and a genuine shift (at least in the context of recent history) from ideology-based politics to politics of national identity has meant that previously unthought of outcomes have come to pass.
As a result, it is understandable that the consequences of recent political events are painted as being both significant and uncommonly impactful in the context of economic growth and financial markets. Those in the “distracting backdrop” camp, meanwhile, cite the resilience of the global economy, robust equity markets, checks and balances on disruptive policy, and the fact that the wheels of politics are slow to turn as the pillars of their case.
While those are true on the whole, complacency remains a risk. The other camp will point out that, although equity markets were surprisingly robust in the face of Brexit and the Trump election victories, sterling and bond markets were not, so it would be incorrect to say that there were no financial market impacts from last year’s events.
Additionally, they would argue that the extremely cautious positioning of the markets at the outset of 2016 (when there was genuine fear of a global recession) has perhaps resulted in a false sense of security that all such surprises will be welcomed with the same equanimity. In other words, our starting point is not the same.
Falling systemic risks
So while market participants take their seats for the high stakes European elections over the next few months, determining which of the above camps to join, I would instead draw investors’ attention to a couple of factors that I believe are being somewhat overlooked as politics dominates the headlines.
The first is that the market is yet to fully accept the idea that the risk of systemic shock has reduced significantly.
It could be argued that there have been three contagion risks that investors have faced over the years since the financial crisis – political contagion (spread of populism), sentiment contagion (belief in stagnation) and economic contagion (crisis in one economy leading to demand destruction in others). Of the three above, the market has been (correctly) most fearful of the last one and this has, to a significant extent, explained why top-down analysis has taken centre stage over the last few years in most investors’ consideration.
The truth is that real economic contagion spreads through the financial system and the points of vulnerability are when the system is highly leveraged and tightly interconnected. We have been moving in the opposite direction over the past eight years.
If this point is valid, it starts to put politics and macroeconomic events into a perspective that I would argue we are still lacking. There are many negative outcomes that investors fear, but constant labelling of events as black swans arguably gives them a status that they do not warrant. By way of illustration, it could be argued that a chain of events (not hard to imagine) that led to Greece leaving the EU and the single currency would be of equal significance but smaller consequence in 2017 or 2018 than it would have been in 2012.
The good news
The second is that, whatever is happening in the context of the political debate, technological development is both rapid and boundaryless and will have a greater impact on consumer tastes, wealth creation, and corporate success and failure than the vast majority of government policy. It is notable that despite the US government’s stated strategy being designed to bolster and provide economic amnesty to some of the most embattled old economy sectors within the US, the Nasdaq continues to post impressive returns.
Taking this signal from the market, perhaps our most critical task as investors over the coming years is to analyse the extent to which technology shapes the corporate landscape, unlocking new opportunities for already leading franchises, or reshaping the economics of long-established value chains across different industries. The good news is that while the political environment continues to enthral most market participants, there is scope for the kind of sentiment swings that can throw up good long-term opportunities.