Common sense would suggest that political uncertainty should weigh on a country’s stock market.
If investors can’t determine with a reasonable degree of certainty which policies will be enacted and when – such as whether taxes will be cut or not – it stands to reason that stocks should be less attractive.
Back in January, I wrote that the U.S. was about to become the world’s largest emerging market. I said:
Political risk expert (and a former boss of mine at Eurasia Group, a political risk analysis consulting company) Ian Bremmer defines emerging markets as “those countries where politics matters at least as much as economics for market outcomes”. This suggests that the usual suspects that investors look at for signs of market trajectory – economic growth, inflation, interest rates, for starters – are downgraded to only be as important as politics. And in some cases, individual leaders can change institutions, further swaying markets.
According to this definition, the U.S. is taking on some of the characteristics of emerging markets – that is, where political risk matters more.
U.S. President Donald Trump moves markets with politically motivated comments about companies, industries and countries in a way that’s far more common in emerging markets than – historically at least – developed markets. He talks about the NAFTA trade deal and the Mexican peso gyrates. A seemingly offhand remark about a company can send its market value down by hundreds of millions of dollars.
Earlier in the year, I suggested that if U.S. markets were to act more like emerging markets, they could be in for a fall. That’s because emerging markets historically trade at lower valuations (like the price-to-earnings ratio) than developed markets. So in order to adjust to a lower (closer to emerging market levels, that is) P/E ratio, either earnings would have to fall, or prices – of shares, that is, overall – would have to fall.
Does political uncertainty matter for U.S. markets?
That hasn’t happened (yet, at least). This is partly because the broad policy outlines sketched by President Trump – few of which have come to fruition yet – are seen as pro-growth and market friendly. Infrastructure investment, tax cuts, and taking an axe to regulation perceived as anti-business are all ingredients for a bubbly stock market, at least in the short term.
So far, this has outweighed the greater political uncertainty of President Trump. The S&P 500 has risen a bit more than 6 percent since the U.S. election in November. It’s up almost 7 percent in 2017 so far.
The U.S. market isn’t the only one where uncertain and volatile domestic politics are not hurting (and perhaps even helping) stock market returns.
South Korea is up
South Korea has a nightmare neighbour to its North. Though a war of anything other than words is unlikely, you might think that investors in South Korea’s stock market might sell just in case. What’s more, the country’s president was recently impeached and ousted, and citizens go to the polls for presidential elections on May 9.
Meanwhile… South Korea’s Kospi Index recently hit six-year highs. It’s up 17 percent in U.S. dollar terms in 2017 so far. The won, Korea’s currency, is up almost 7 percent against the U.S. dollar.
So is Turkey
Turkey’s president Recep Tayyip Erdogan recently won a referendum that grants his office significantly expanded powers. Even before the polarising referendum, Turkey was headed in a dangerous direction, by western democratic standards. “Erdogan’s thirst for one-man rule threatens Turkey,” warned a mid-March opinion piece in the Financial Times.
A few days ago the government moved to restrict television dating shows and it blocked access to Wikipedia, as part of a crackdown on the media and internet. By western liberal standards, Turkey is going to the dark side.
So how is the Turkish stock market doing? It’s up 21 percent in U.S. dollar terms in 2017 so far. The country’s currency is roughly flat.
What does it mean?
Trump’s market-friendly policy announcements – even if they’re getting bogged down in execution – are moving markets more than the president’s muddled delivery and his trigger-happy Twitter fingers. The anticipation of a strong economy can mean a lot more than political uncertainty.
Also, what bothers journalists doesn’t necessarily bother investors. The president of the Philippines – like his colleague in Turkey – has become a poster child for stomping on human rights. But the country’s stock market is up 12 percent this year.
And don’t forget… it’s all about your time frame. How markets view a policy or a politician changes over time. Today’s contrarian view is tomorrow’s consensus view. Measures or words that bolster markets now may be a slow-burn fuse that blows them up months later.