The tragic events in Paris last Friday have rightly captured hearts and headlines but the markets have so far remained relatively unfazed by the recent escalation in geopolitical tension. At least partly, this stems from lengthy experience –geopolitical crises have generally had a far higher human than economic cost.
Markets have become prone to dismissing other potentially disruptive political events – to pick an entirely different example, the UK referendum on Europe remains largely ignored by markets, despite the undoubted volatility it may cause.
Is it right that geopolitical events should be so readily dismissed by markets? It is clear that, in certain circumstances, politics can have a profound and lasting impact on economies.
In Japan, for example, reforms on corporate governance have helped focus the attention of company management teams more closely on shareholder returns. Dividend pay-outs have improved and share buybacks increased. This has all been important in generating the strong returns that investors in Japanese markets have seen over the past 12 months.
At the opposite end of the spectrum has been Brazil – where economic mismanagement has been instrumental in the near 40% fall (in US dollar terms) in the stockmarket over the past 12 months. The Petrobras scandal and apparent involvement of senior government figures have been vital in creating widespread investor disaffection with the market.
Equally, it is clear that if, for example, Jeremy Corbyn were to end up as the UK’s prime minister, certain companies would be profoundly affected. Would it be possible to take an apolitical view on First Group, say, in a climate where the rail network might be re-privatised? This year’s General Election showed that, even in sophisticated market economies, politics can have a profound impact on investor sentiment and returns.
The problem is – as the General Election also showed – the outcome of political events is extremely difficult to predict. Who can really judge whether Corbyn has a chance of being elected? The consensus suggests not, but there is a possibility he may galvanise into action the 35% of people who did not vote in the last election.
Ultimately, a recognition of the potential impact of politics is a vital part of risk management – even in developed economies. To suggest it is possible to select stocks without an appreciation of the political environment in which they operate is disingenuous. At the most basic level, politics makes fiscal policy, which influences economic growth, which influences the extent to which companies can grow their earnings. It is hardly something investors can ignore.