With both the UK budget and the US election out of the way, Anthony Rayner gives his views on how to deal with these events from an investment perspective. Though reluctant to take conviction positions around political events, he highlights how once the dust has settled, there are often trends to observe.
Political event risks, and indeed opportunities, are nothing new but have been front of mind for markets of late, in particular the US election but also the recent UK budget. Both events are now out of the way but how should we deal with these events from an investment perspective?
Ahead of the event, there tends to be a lot of noise, fed by regular coverage/polling and the media circus in general, which often add to volatility. The graph below shows how US Treasury volatility was at a YTD high ahead of the US election, with much of that recent spike driven by election uncertainty in the US, and specifically the degree of fiscal discipline expected. As event outcome uncertainty disappears, volatility tends to subside (as the graph shows). Then, more often than not, markets carry on where they left off, maybe with some sort of relief rally, in this case in equities not bonds.
US Treasuries and G10 currency volatilities were at a YTD high pre-election
Source: Bloomberg 22.05.2019 – 07.11.2024
Importantly though, the event outcome and what it means for markets, economies and societies is difficult to be objective about. Investors often have a personal point of view, based on personal experience, and political allegiance. The regular polling data also feeds conviction, often misleadingly. This combination of elevated conviction and elevated emotions is not the best foundation for a sound analysis.
As a result, our general approach is to limit exposure to single day event risks such as these, as they are normally characterised by poor visibility, i.e. for both the event outcome and then the subsequent impact on financial markets. Brexit was a great reminder for many investors of what not to do. First, don’t always assume the polls are correct, which were pointing to a remain victory. Second, don’t assume that the more uncertain outcome, in that case the non-status quo Brexit, will be bad for markets, as getting the event uncertainty out of the way can lead to some degree of relief rally. In short, just don’t assume!
However, whilst we are reluctant to take conviction positions around political events, once the dust has settled there are often trends to observe. Clearly, a Trump victory with a likely clean sweep of both Houses of Congress (the latter of which is not yet confirmed but very likely), will be business and growth friendly, with the exception of likely tariffs, and this will be broadly positive for equities.
However, one of the emerging trends from both the US election and the UK budget is the move higher in government bond yields, as investors fret about concerns over higher borrowing and the related concern of higher inflation. Maybe bond vigilantes have come out of hibernation and are starting to sharpen their swords.
More generally, another trend is how badly incumbents have done this year, not just in the US and the UK. Part of this will be down to the poor economic environment, including low growth (outside the US) and higher cost of living, particularly the accumulative impact, rather than the year-on-year inflation measure the markets focus on. Immigration is also an issue that incumbents have been punished for by voters in a number of countries.
In summary, market behaviour around these two events supports our belief that it’s generally best to look through the noise, and avoid getting drawn in, no matter how tempting. Instead, focus on any emerging trends. The single most fascinating dynamic to emerge from both of these events is how government bond markets are struggling to digest the potential of increased supply, in both the US and the UK. This is one to watch in our opinion.
Importantly, this supports our higher for longer inflation view, as ever decreasing fiscal discipline (along with increased trade war risks) adds to inflationary pressures. In portfolios, we retain our short duration bias in bonds generally and have a material exposure to equities, particularly US equities and our reshoring theme. We also maintain a significant exposure to gold, to diversify geopolitical risk.
