Political risks and stocks

I just read a Gillian Tett piece (could be behind a paywall) in FT published two months ago. She felt that investors (stock markets) should heed political risks. She had referred to the probability of a Presidential impeachment suggesting that markets have not priced that in! But, to be fair to her, the article suggested other important issues and considerations.

I had posted the following comment on her article:

It is good to see some very interesting, insightful and useful comments on the article. I loved the comment by Mr. Graham Lovell from Australia. I am reading the ‘Global Economics History: A Very short Introduction’ by Professor Robert Allen. He notes that the economic model for Western nations in the 19th century and in the early part of the 20th century before the wars and the Depression intervened was: mass education, mass banking, national markets and external protection. Colonisation helped the British to source raw materials cheaply and force their finished products on colonies, decimating the colonies’ manufacturing base. De-industrialisation.

So, free trade was not the formula or route to economic growth and prosperity. It has helped many to prosper in the developing world too, no doubt, in recent decades. But, that is a very small portion of their overall population. India is an example. China benefited in the last three decades but it practiced exactly the kind of ‘free trade’ that today’s advanced nations practiced in their early development phase.

So, Trump’s model – if it can be called that – is very consistent with international empirical evidence. Now, I certainly do not think that American stock market investors had been very perceptive enough to understand this and price it in, because the stock market was not cheap by any means when he took office.

That the stock market has not been pricing in geopolitical risk is not something unexpected. One, average holding periods have shrunk to a few months. Two, stock markets (and, financial markets more broadly) have demonstrated a singular lack of ability to price in either complex or long-term risks. Since the 1980s, global debt and debt in advanced nations, in particular, has risen in absolute terms and as a percentage of GDP to today’s unsustainable levels. What did stocks and bonds do? In the last three decades or so, bond yields have been in secular decline and stocks have also move higher, in sympathy with declining yields.

So, financial markets are myopic – both with respect to the factors that they discount and their horizons.

Third, we should not forget that the Federal Reserve monetary policy is in the process of moving away from being ‘extraordinarily reckless’ to ‘somewhat extraordinarily reckless’. The European Central Bank has not stopped its ultra-loose policies nor has the Bank of Japan and nor has the Bank of England and scores of other smaller European nations. China’s liquidity splurge in the last few months that has restored economic growth to ‘respectable’ levels too must have found its way into international assets via capital outflows, at least until very recently.

So, in a sense, the stock market rise in the last few months could very much be explained by generous liquidity and ‘still irresponsible’ monetary policies in most advanced nations and not attributed to President Trump, for the most part.

There is a small role for him and his policies in the sense that investors could have ratcheted up their earnings expectations anticipating a large corporate tax cut. But, surely, they had not reduced their expectations after his failure to get health care reform through and after many of his initiatives faced legislative and judicial roadblocks.

Real economic growth indicators – notwithstanding auto sales – had perked up quite a bit in recent months. I am referring to the Chicago Fed National Activity Index (CFNAI), Durable Goods Orders and the Labour Market Conditions index of the Federal Reserve. The index of confidence among small businesses (the sentiment index published monthly by the National Federation of Independent Businesses) had shot up in November and has held there in the last few months. They are anticipating a massive de-regulation under the new administration.

Journalists and academics had paid far too little attention to the chokehold that the regulations of Obama administration had placed on the American economy. On a per day basis, the regulations passed by his administration exceeded that of Presidents Bush and Clinton before him.

So, anticipation and delivery of de-regulation have also had a role to play in the improvement in economic optimism notwithstanding complex political noise. Perhaps, certain sections of the society are sole producers and consumers of their own dissonance with respect to Trump with little heed for any objectivity.

In sum, the stock market ascent of the last few months has something to do with the changed executive focus on regulations but a lot to do with traditional irrational and myopic considerations.

Equally, if the stock markets crash -as they will, at some point – it cannot be pinned on President Trump.


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