Why Current Politics Scare Investors in the US and UKAuthor: Kathryn Gaw
With the exception of a few bullish hedge fund managers, most investors hate uncertainty. Just one grain of uncertainty can quickly snowball into market panic, as sending stock markets crashing and funds shut down. In finance, doubt is dangerous, and uncertainty can prove expensive.
So it is hardly surprising to see investors shy away from the US and UK markets in the wake of recent political upheaval and regime change.
In the UK, the Brexit fallout saw the pound slump to a 31-year low, and a slew of major property funds close down amid fears of an impending property crash. And in the US, a Congress gridlock, a spate of terrorist attacks, and the prospect of a President Trump means that political risk is being factored into US-facing investments in a very real way. In fact, high profile economist Larry Summers recently said that political risk is currently a huge economic risk for the US, in a way that is usually reserved for emerging markets.
US and UK equities have always been viewed as relative ‘safe havens’ offering steady returns over time. As a rule, risk-averse investors do not want to be exposed to market volatility, so it makes sense that they would divest at the first sign of uncertainty and divert their money elsewhere – into gold, bonds or even cash. But this is not the only reason why investors are monitoring US and UK politics for investment prospects. In the current economic climate, it is hard to know what’s going to happen next, and there are a few scenarios that are worrying investors: interest rates; policy shifts; and good old fashioned geo-political risk.
1. Interest rates
In times of crisis, governments typically respond by lowering the interest rates of their central banks. Japan did it; Sweden did it; and both the UK and the US did it in the wake of the 2008 financial crisis. The idea is that by reducing interest rates, banks will be able to offer cheaper lending to their clients, stimulating spending in key sectors such as construction, property and retail.
However, while low interest rates may benefit borrowers, they are bad news for anyone with a savings account or significant cash holdings. Furthermore, due to post-2008 capital requirements, there are strict limits on the ratio of capital vs debt which can be held by US banks. This means that some banks may be unable to take full advantage of the low interest rates, leaving them saddled with a less ‘valuable’ debt sheet compared with other banks, weakening their stock prices and impacting on the financial sector as a whole.
2. Policy shifts
With every regime change comes at least one major policy shift. In the UK, David Cameron has led the Government since 2010, when the top priority was stabilizing the post-2008 economy and reducing the country’s deficit. Six years later, the priority is the UK’s departure from the EU. At the time of writing, new prime minister Theresa May was yet to name her cabinet and lay out her key policies. No matter what sort of Brexit deal is negotiated, it is likely to result in a brand new budget and a reshuffling of the country’s finances. What this means for investors will remain to be seen.
Likewise, in the US, the next president will have de facto control over the world’s most influential economy. If Donald Trump wins the election, his policies on immigration, taxation and borrowing could tank the American economy, according to a number of economists , while Hillary Clinton has already pledged to raise taxes on the wealthy if she takes office . No matter who becomes president, there will be changes afoot for the US economy, and this will have a direct impact on how investors view the prospect of US equities and bonds.
3. Geo-political risk
Geo-political risk is normally a category reserved for emerging and frontier markets, but analysts are beginning to factor this into their investment outlooks for the US and (to a lesser extent) the UK.
In the US, there has been an increase in guerrilla-style homeland attacks linked with Isis , while racial tensions remain high following the deaths of black men in police custody in Ferguson, New York City and Baltimore, and the retaliatory killing of five police officers at a Black Lives Matter protest in Dallas, Texas . Any outbreak of violence will have a knock-on effect on consumer services and tourism, and investors will be wary of this when updating their portfolios.
In the UK, the political unrest has been largely peaceful, but rumors of an upcoming Scottish referendum, and a possible reunification of Ireland and Northern Ireland means that serious upheaval could quickly become a reality.
So what will reassure investors?
Investors need to have a plan, and any plan is better than no plan. The accelerated appointment of Theresa May as PM has already been a good thing for the UK economy , boosting the stock markets and stabilizing the pound. Her next challenge will be handling the invocation of Article 50 and bringing the UK out of the EU as calmly and smoothly as possible.
In the US, November’s presidential election will offer some clarity on the future of the country’s economy, for better or for worse. Regardless of the outcome, investors will find reassurance in the certainty of either a Trump or Clinton presidency, and they will be able to reallocate their portfolios accordingly.
However, 2016 has already been one of the most unpredictable in recent memory in terms of politics and the economy, so investors would be forgiven for holding off just a little bit longer.