For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
What to do about rising political risk?
More people will vote this year than in any single calendar year in history and, with that, political risk has been rising across the globe. More specifically, election risk has been under the spotlight.
Through our risk lens, we consider elections as a binary single day risk event. This might sound like quite a dry description, especially for events that often take place against a carnival style backdrop, but it’s healthy to provide an objective definition in situations where investors are often tempted to build a conviction position either way.
This temptation arises for a number of reasons, none of which are particularly sound. In the run up to election day, predictions of the outcome are numerous and highly convincing but often plain wrong. Conviction can build with every poll, which are often released daily, but even exit polls can be quite misleading, as demonstrated in India quite recently, where several exit polls suggested Modi was going to win a two thirds majority, only to win without a majority at all.
If the election is in an investor’s home market, the temptation to increase conviction tends to increase further. Frequently, domestic investors will take more interest and start to believe they have more insight. In addition, emotions run high and biases develop due to their experiences in the previous political term and their own political ideology and/or party allegiance, all of which tend to contaminate objective thought. Brexit is a recent reminder of how wrong the narrative can be.
However, even if investors do get the outcome correct, the impact on the local equity, bond and currency markets is still far from obvious. In short, markets struggle to price the complexity of political risk and so volatility tends to increase in the short term. For example, when the consensus view in Mexico and India turned out to be wrong there was a big response from markets. Taking India as a case in point, the chart below shows how the market flapped around a bit around the election but ended up back on trend.
Indian stock market
Source: Bloomberg 24.03.2023 to 13.06.2024. Past performance is not a reliable indicator of future returns.
Further out though, the impact of elections on financial markets is less clear cut. In fact, quite often, despite the expectations, little changes fundamentally, as many pre-election promises don’t turn into legislation, especially when both the main parties have a centrist bias.
Even though we avoid building outcome dependant positions around elections, there are some general observations that we can make about upcoming elections. Democracies are struggling to meet their side of the social contract, with high cost of living, high immigration and low credibility of politicians and political institutions front of mind for many voters.
As a result, traditional parties are struggling, with more populist parties taking much of their vote, some of which will have a nationalist bent. Trade wars, immigration and foreign policy will feature high up on the agenda for many. As will the desire to continue to loosen fiscal discipline, even though already high debt levels might limit spending options. Related to this, with geopolitical risk rising across many areas in the world, government spending on defence will become an even bigger part of expenditure.
There are still some major elections to come in the second half of the year but we continue to avoid outcome dependent positions, however tempting. Instead, our focus remains on the macro and thematic environment but even here we maintain many checks and balances to ensure unhelpful emotions don’t creep into decision making.
