Election Cycles and Investment returns

This year, over 4 billion people are voting to shape their country’s political and economic outlook for the next three to five years. From India to France, Mexico to the UK numerous general elections are taking place.

Saturday, July 27th 2024, 5:14AM

by Octagon Asset Management

Arguably the most important election for the global economy will be in the USA in early November. With the Democrats fielding a new candidate after Biden’s withdrawal and the attempted assignation of Donald Trump at a rally in mid-July, this US election cycle has already created history like few that others that preceded it.

Octagon believes that markets price in elections in a similar way as they do about most other new information – be it economic, political or geopolitical. Investors in both equities and fixed interest watch news and developments every day. They take that incremental piece of news, add the data and the chances of it happening to their current view and make changes to the likely future outlook for the assets they invest in.

When it comes to elections, as with most pieces of new information, it is the “surprise” element of the news that has the biggest short term effect on markets. While an assassin’s bullet would have been both shocking and surprising, perhaps the best illustration of a surprise that jolted markets was the most recent French election and how it compared with the UK election just a few days later.

The market did not expect a snap French general election to be announced in early June. Both French equity (minus ~6%) and fixed interest markets (minus ~2%) moved materially in the few days after the election was called as investors changed their views of possible future outcomes. In the following weeks markets gathered more data every day and as of the first week of July, both French equity and bond markets had recovered about half their losses. Surprises keep being delivered as odds of a left or right-leaning government change, but their impact on asset prices are reduced as investors build this new information into their future price expectations.

On the other hand, in the UK, it was very likely that a change in government would occur and that is exactly what happened. In the months preceding the election, markets had already priced in the change of government and what it would mean for the economy, politics and asset prices. On the day, there were no surprises with the Labour party winning and investment markets barely moved as a result of the widely expected ‘news’.

The market will continue to learn more about the new government’s longer term policies, and arguably surprises in policy might still deliver short term volatility, but the election result itself was priced in by investors.

In our opinion, the impact of multiple election cycles is unlikely to have a lasting impact on long-term investment returns, particularly if you have a well-diversified portfolio. The period during which we are each saving for our retirement is likely to include at least 10 election cycles. National or Labour or a coalition, Democrats or Republicans, Conservatives or UK Labour – all have their turn sitting on the government benches. All have pushed their own priorities, yet when looking at charts of long-term returns, it is hard to tell who was in power and whether one set of policies was better for returns than another.

One of the key reasons for the limited medium and long-term impact is that investment markets send strong messages to governments about what are acceptable economic policies. The 1992 US election coined a phrase that is most often repeated as “It’s the economy, stupid”. I interpret this to mean that whoever is in power, or trying to get into power, has to have policies that the voters (who are also investors) think will be good for the health of the economy.

A recent example of this feedback loop from markets to politics occurred when Liz Truss (Prime Minister of the UK at the time) announced new policies in September 2023. She announced tax cuts funded by raising government debt levels. The lower taxes were meant to encourage investment and growth, making the higher levels of debt sustainable. Investment markets fiercely disagreed and the feedback loop was short and sharp.

UK fixed interest markets felt that the policy would put the government balance sheet under pressure, immediately raising interest rates (which would also increase the government interest bill). The British Pound fell as global investors didn’t like the increase in level of debt either. The Central Bank quickly stepped in to stabilise markets, most of the policies were watered down, and the PM lost her job within six weeks. Fixed interest and equities markets recovered their losses by mid-November 2023, whilst the currency regained its June levels by the end of 2023.

Even in economies where the government has total control of all economic activity and there are no free elections (think North Korea), it is ultimately the strength of the economy and employment markets that determine policy responses. A discontented electorate can mean a leader losing their job and lead to an increased risk of civil unrest and threats to party power.

None of this is to say that elections have no impact at all, and big shifts in economic policy that change the economy’s growth rate will eventually show up in that country’s returns. An investor only need look at the seismic changes that occurred in New Zealand’s political landscape after the 1984 election brought to power the fourth Labour government and with it incredible social and economic reforms from ‘Rogernomics’.

However, in the long run though, over 130 years of various political and geopolitical changes, the drive of individuals and organisations to innovate and compete and earn a profit in the production of goods and services has served investment markets well.

Tags: Octagon Asset Management