You may hate them, you may love them, but you canât ignore them.
We elect politicians who are responsible for policy decisions and forming regulations that govern the nation, and we have seen markets reacting to certain Tweets of politicians or other political shocks.
So, the question arises does the politics really influence the markets?
As an investor you might not be involved or interested in the political matters of your country, but this front matters a lot when it comes to your investment risks and returns.
Letâs take an example from the trade war between the US and China! In the US market, investors acted in a terrifying trend, presuming a big shock in the prospect following elevated trade war between the two major economies. The countries have slapped tariffs on each other goods, hurting the business sentiments and export activities, globally.
Trumpâs Example - Moreover, recently, the headlines regarding impeachment proceedings against US President Trump overshadowed any other major event. Trump warned that the impeachment may clatter markets, and the stock markets traded down on the warning.
As political news continues to centre the stage, these would have a temporary but a definite impact, leading to high volatility in the market. But if in case you have a long horizon, these swings should not bother you, rather capitalising on such news can offer you gains. As per the principles of value investing, if the markets are hitting their low, it is the good time to enter and proffer accumulation. Â
While the economists and policymakers argue on what the conditions would be, the markets already absorb the information and start performing accordingly. The falling trends in the prices along with the contraction in output make situations difficult for investors and they find hard to prosper. This not only affects the investors but companies too! They even start selling their assets to pay off their debts. This is a never-ending circle rather a vicious circle where the debt keeps piling up and companies keep selling their assets. Central banks in several countries are expected to cut interest rates, resulting in easing the monetary policy. Softening domestic outlooks, falling growth rates and prospects, low inflation, and deteriorating business and consumer confidence further adds to reason out softening of monetary policy.
Brexit brings out an amazing example to such events. This is the situation wherein; the United Kingdom leaves the single market of the European Union without a replacement to cooperate closely with the continent via economic and regulatory coordination. The SEC and the trading commission also released warning statements for potential disruptions in the financial industry. Investors are still seeking clarity on what is to be done, as tariffs are being threatened.
This situation is not favourable for the citizens of the US either. Investors are already leaning towards the less risky securities. Investors here are not to be blamed, as it is not very likely that they are going to stick out to their necks anytime soon.
Do Elections Matter?
Apart from geopolitical risks, elections too have a negative effect on equities sometimes. Elections and stock markets are related because investors are risk averse and like stability in the market. The general thought of people is that if there is a stable government and is investor friendly, markets would grow. Political news for sure play an essential role in the unpredictability of stock returns. However, investors do not require risk premium on securities as the idea is this - political risk is diversifiable. The volatility fluctuates from a firm's exposure to political risks, dependent upon the asset structure, foreign investments and various other factors.
General elections across all countries bring in new policies that impact the stock market either in favour or unfavourably! There are always discussions on where to invest during the time of elections. Financial markets tend to underestimate political risks when struggling to forecast the share prices. Once the event happens, it creates panic in the market. Then they tend to overestimate risk.
The Way Out
Amidst all political tensions, the only thing investors are concerned is how to mitigate this political risk and how to protect their portfolio. But political decisions are so opaque that fretting doesnât help foresee the timing and effect.
One way out is Diversification. Remember when we use to go out on a trip and our mother used to tell keep your money in different pockets rather than keeping all of it in your wallet, so that even if you lose some you will have enough to reach your destination.
Likewise, if you diversify, no matter what the conditions are, you will never lose the entire gains. When the markets are elevated even the risk averse investors start taking higher risks, which result in asset allocation different from your ability. Hence, it is important to rebalance your portfolio. This means in the time of instability, either a boring investment portfolio or a safe diversified portfolio with short term bonds and gold may help.
In conclusion, impact of politics cannot be ignored. At the same time, it is not advised to overestimate the risks of sudden political decision; markets generally account for changes very quickly. These markets are affected by various factors such as changes in policies, interest rates and of course politics. However, investors who panic and exit the markets may regret it later. Therefore, to summarise, politics should be taken into consideration to make investment decisions but over relying on some information may turn out to be very risky.
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