Markets update - is political risk back?
So much has happened in the last three months that we could be forgiven for assuming nothing has stayed the same since the COVID-19 outbreak. Yet the investment world is slowly returning to some form of normality as it looks again at things like liquidity, government policy, valuations, economic fundamentals and of course political risk, rather than focusing only on virus data.
It would have been very beautiful for the human species to lay aside its differences to fight this common enemy, but it didn’t happen. Every country (and in the US, every state) has done things differently with little coordination. The worst may be over for the virus, but political issues are back to the fore for investors.
An election, trade wars and civil unrest
The US is at the very centre of political risk right now due to the election in five months, where President Trump faces former Vice President Biden (now ahead in the polls). Trump’s latest campaign moves include trying to capitalise on the general distrust of China in the US, recently seizing on Hong Kong’s unrest and slapping sanctions against Chinese officials. Of course, China soon retaliated by suspending some purchases of US agricultural goods.
Trump may even try and portray Biden as ‘China’s candidate’. Par for the game in an election, but the problem is the Phase 1 trade deal between the US and China, which provides for China to make large purchases of US food products. Mid-western farm states need these orders and Trump needs these states to vote for him, so the stakes are high.
Importantly, trade developments between the US and China have generally determined market sentiment for US equities - and indirectly for the rest of the world. Ending the Phase 1 trade deal would not be good for risk appetite.
More recently, the demonstrations and riots related to the death of George Floyd have put further pressure on President Trump to manage the situation and he has been found wanting by some members of his own Party and administration. Journalists have unearthed the precedent of Richard Nixon’s re-election against the backdrop of civil unrest, when he played the law and order card. Trump therefore is trying to follow that template which might mean a tense lead-up to the 3 November election date.
Markets normally start to focus on the US presidential election around August and tend to predict the winner, preferring the incumbent to the challenger. We will be watching this one with interest.
On this side of the pond, relations between the UK and the EU, never rosy, are now visibly deteriorating. It is not clear who is bluffing whom about walking out of the potential trade deal at the end of this year, but there is now an increasing risk that UK companies are going to have to hire 50,000 people just to fill in the customs forms needed in the case of a no-deal Brexit. Markets are sanguine about this risk, since they assume there will be a resolution made at the last minute, but the uncertainty cannot help businesses still reeling from the lockdown on either side of the Channel. This uncertainty would normally get reflected in a weaker sterling, which could make UK investments less attractive at a time when the Government is borrowing large amounts and needs global participation.
In the midst of all this gloom, it seems a glimmer of hope has emerged from Europe, of all places. Chancellor Merkel of Germany and President Macron of France have announced a large package of COVID-19 support for EU countries, including €750bn of bonds issued by the EU to lend to countries most affected by the virus (Italy, Spain, etc.). The fiscally-responsible nations (Sweden, Denmark, the Netherlands, Austria) have expressed some concerns but not vetoed the proposal. This deal is vital if the EU wants to hold together, as the southern European countries, which had the worst coronavirus experience, have felt let down by the rest of Europe. Germany is usually sceptical about federal lending so, for it to take the mantle here, makes it more probable that the project will succeed. As a leader, Angela Merkel has also had the ‘best’ COVID-19 crisis, as Germany has had a lower death rate than comparable nations and confidence in its government is the envy of other western countries.
Back to the realities of politics and investing
As we lift lockdowns, people return to some level of normality and the economy recovers from the worst crisis in living memory, we also come back to the realities of investing. The Fed (US Federal Reserve) and the other central banks of the developed world cannot solve all problems for investors, and that includes political risks. Markets will have to face up to them at some point.
Fortunately, investing is not just about navigating market sentiment but also about picking ideas and themes that have a long-term future above the fray of daily market and political worries. Our environmental, social and governance investment ideas (ESG) have taken well and seem to be off to a good start. You can read more about these in our article, ‘the top five ESG sustainable and responsible investment themes shaping our future’. As ever, we will keep you informed of these and other investment opportunities.
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IMPORTANT: Investment involves risk. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested. Past performance is not a reliable indicator of future performance.