19. Jul 2019 Equities

The impact of politics on markets is usually short-lived

“The impact of politics on markets is short-lived.” This piece of market wisdom is generally correct and for investors with strong nerves creates attractive entry points.

  • Investors should not overestimate the impact of political risks such as surprising election results. Markets usually return to normal pretty quickly.
  • The decisive price drivers for financial markets are the economy, interest rates and earnings performance.
  • Over the longer term, however, the political environment definitely influences what happens on the stock market.
4 minutes to read

Neither the surprising Brexit vote nor the election of US President Donald Trump managed to upset markets for long.

Market wisdom check

On the stock market, investors are confronted with all kinds of received wisdom. However, this advice is not always accurate. We need a reality check. Let's have a closer look at this maxim: “The impact of politics on markets is short-lived.”

Stock market investors wish for simple rules that address fundamental questions. For example: when should I purchase a stock and when should I sell it again? Some investors take direction from received wisdom that has sometimes been circulating for decades and is quoted again and again.

According to one adage, the impact of politics on markets is short-lived. Is this just a saying, or is there something more to it?

Fundamental data provide direction

First, we must establish what this adage means. It refers to surprising political events, such as unexpected election results or changes of government. Such events can cause intense market reactions, which normally push prices down. But in just a short time the markets should return to normal, which is why the phenomenon is short-lived. After all, fundamental economic factors, such as interest rates and business trends or companies' earnings cycles, affect financial markets the most.

The year 2016 provided two vivid examples of politically driven markets. The first was the UK's vote to leave the European Union (Brexit) at the end of June, which was a surprising win for the Leave campaign. However, after a brief shock, markets began to return to normal in just a few weeks. This was partly because investors hoped that the UK and the EU would find a mutually acceptable solution.


Long-term Performance

06/14 - 06/15 06/15 - 06/16 06/16 - 06/17 06/17 - 06/18 06/18 - 06/19
Dax 11,3 % -11,6 %  27,3 % -0,2 % 0,8 %

Past performance is not a reliable indicator of future performance.

As politics creates the economic framework, it can definitely have a great effect on stock markets over the long term.

Several months later, markets were in uproar again as Americans elected Donald Trump US president, surprising many. The impact of politics on markets was very short-lived in that case, as stock markets fell and rose again in just a few hours. That is often the pattern after elections. It is unclear whether and how they will affect economic policy, and so investors relax after the initial excitement has passed.


Some risks only show up later

Nevertheless, it would be incorrect to think that politics has no effect on market prices. During the euro crisis, which ended in 2010, financial markets were for months spellbound by speculation about bailouts, the introduction of joint euro government bonds and European Central Bank intervention. This showed that politically driven markets can be very long-lived.

The current trade war between the USA and China could also keep financial markets busy. There is a risk that the positive effects of free trade from globalisation could be reversed. The fears that arose shortly after US President Trump's election could therefore prove well-founded in the long term. And the last word on Brexit has not yet been spoken. If the UK does opt for a hard separation from the EU with no withdrawal agreement, that could affect business and profits on both sides of the English Channel, weighing on share prices. Most professional investors are also convinced that the impact of politics on markets is short-lived. In a survey from the Deutsche Vereinigung für Finanzanalyse und Asset Management (DVFA) [German Association for Financial Analysis and Asset Management][1], 63 percent of those surveyed shared this view. However, 59 percent also believed that the general influence of politics on capital markets is increasing.


Calmness trumps all

How can investors use this knowledge? Anyone interested in long-term wealth creation should look on short-term ups and downs as normal market movements and wait them out, even if things look rather hectic at the time. The more broadly diversified a portfolio is, the better this works. By contrast, investors who succumb to general panic and liquidate their portfolio without due consideration usually soon regret it. Investors with strong nerves can even use politically driven markets as favourable market entry points.

Investors should not succumb to general panic and hastily sell their share holdings. Fear is always a poor advisor.

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1. Source: https://www.institutional-money.com/news/maerkte/headline/gilt-der-satz-politische-boersen-haben-kurze-beine-heute-noch-immer-133586/

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