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Factoring in political risk

29 June 2017

Markets struggle with political risk because, as recent times have shown, politics is a funny old business, says Anthony Rayner, manager of Miton’s multi-asset fund range.

In April it looked like Theresa May was right to call an early election. She seemed a safe pair of hands, the opposition was in disarray and a larger majority would strengthen her hand in forthcoming complex Brexit negotiations. It all sounded sensible enough, but politics is a funny old business.
Fast forward two months – Brexit negotiations have started, the Conservatives have lost their majority, Theresa May is now almost as unpopular as Jeremy Corbyn was at the beginning of the campaign (YouGov), and Labour are ahead in the latest opinion poll (Survation).

What happened? The election debates were principally around Brexit, austerity and, as always, the ability of candidates. Brexit remains a divisive issue for both parties, but Labour largely steered clear, while the increasing evidence of ‘austerity exhaustion’, played well to Labour’s left wing manifesto.

However, the shift in perceptions towards the party leaders was the game changer. One focus group member said she would “trust Theresa May to look after her house, but not her pets.” That sums up the leader’s perceived ‘empathy deficit’ well, further highlighted since by her response to the Grenfell Tower disaster.

Post-election surveys have been illuminating. Class is now much less an indicator of voting intention than age. Older groups remain steadfastly Conservative, despite the ‘dementia tax’ debacle, but younger groups overwhelmingly preferred Labour. No doubt, part of this shift is that wealth inequality is so evident across demographics, while younger voters didn’t experience Labour’s Winter of Discontent in the late 1970s. Importantly, while turnout among younger demographics was up sharply, it remains markedly below the rate for older groups.

So what do these events tell us about financial markets? Most importantly, they serve as a reminder not to get tangled up in forecasting political outcomes, despite the temptation to believe the polls, even if you think you can discount your own political beliefs from the equation.

Forecasting political events has become even harder in recent times. Demographic and technological changes, such as the shift from traditional media to social media, are testing forecasting methodologies. These dynamics combine with the fact that many voters want material change (note how relative newcomer Macron blew away France’s mainstream parties in recent elections), adding to the difficulty of forecasting.

Economic growth in the UK has been more resilient than many thought post the Brexit vote, but headwinds are building, with inflation growing ahead of wages and the consumer showing signs of flagging. We can afford to sidestep the questions that are “too difficult” from a risk/reward perspective, as we manage global multi-asset funds, so our exposure to the UK economy is limited.

What about the pound? There are many reasons to suggest a weaker pound. The economic environment is weakening and the political environment is becoming increasingly uncertain. That said, the pound might already be cheap enough, especially against currencies like the US dollar which has its own softening economic environment and complex political environment. Again, like politics, currencies are not the place we think we can best build long-term sustainable performance.

So, politics is a funny old business and we recognise that markets struggle to price political risk. Perhaps because politics, as US writer Ambrose Bierce put it many years ago, is “a strife of interests masquerading as a contest of principles. The conduct of public affairs for private advantage”.

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