‘Bull market in politics’ could mean bear market in risk assets
A new era in politics has been a windfall for investors, but the odds are against that being the end of the story.
The S&P 500 has rallied nearly 14 per cent since just before Donald Trump was elected president, a political earthquake, as investors, perhaps rightly, focus not on policy volatility but anticipated tax and regulation cuts and government spending.
That may persist, but Mr. Trump’s particular brand of politics, which gives primacy to domestic jobs over trade, has the potential to cause economic wounds which tax cuts are unlikely to assuage.
Moreover, Mr. Trump’s is just one reaction to a set of circumstances, notably poor middle-income wage growth, which affect large swathes of Europe and elsewhere. If politics is the art of the possible, then investors need to do their sums based on a much, much wider range of outcomes.
“I’m not sure this is a good thing, but it is a fact that maybe politics is becoming more important, it’s becoming more intense, the range of outcomes is becoming greater, and that we’re in a world in which there’s a bull market in politics that’s getting started,” investor and Trump adviser Peter Thiel said on Tuesday.
Mr. Thiel argued that the “tide on globalization is just going out,” saying that people, goods, services, capital and information will all face increasing restrictions of movement.
Every single one of those developments will create winners and losers which can be exploited by investors. So far, U.S. corporations are popularly deemed to be among the winners.
Every single one will also create new risks, and will also, over the medium term, tend to suppress growth and push inflation higher. All else being equal, that should be bad for portfolio returns, as inflation will lower the multiple investors will pay for future streams of cash and lower growth simply means smaller such streams.
All of this is, to be sure, highly uncertain. That is not good news, either. Trump administration policy, while following the broad outlines of what House Republicans said they wanted last year, is just a very strange bird. We don’t know what exactly Mr. Trump wants, what he will bring his Republican partners along on, and what the hybrid will achieve. Trade policy is particularly baffling.
Beyond a mistrust of collective agreements generally and China in specific, it is very difficult to know how U.S. trading partners will react. Will they put up with tariffs or impose their own?
UNCERTAINTY PILED ON IMPROBABILITY
His presidency itself being the result of highly unpredictable forces which, as in Brexit, are in play elsewhere, Mr. Trump is such a departure from previous norms that it only seems reasonable to impose some higher margin of safety on a wide range of assets. This so far has not happened.
Investors should, in theory, demand higher returns in exchange for taking on greater risks. Price volatility is one such risk, and one which has diminished markedly since the financial crisis. As these new and hard-to-predict policies come into force, expect markets to be more volatile, and eventually, investors to mark prices down in response.
Given how generally friendly both globalization and the past 25 years of politics have been to capital, it seems likely that the risks of political change are asymmetrically tilted to the downside. We’ve seen: lower tariffs, of benefit to capital; stagnant wage growth, of benefit to capital; and low or falling tax burdens, of benefit to capital. If those start moving back towards historic norms – if, in other words, labour captures a higher share of output – asset prices will suffer.
Boston University law professor James Bessen is notable for demonstrating that about half the increase in U.S. corporate profits can be traced to political and regulatory gamesmanship, particularly in highly regulated sectors like telecoms. If Mr. Trump’s promised campaign to lighten regulation bears fruit, it will be interesting to see if corporate valuations take a hit. Lower regulation might also help growth, as investors are now betting.
It is of course possible that deregulation by Mr. Trump will be done in such a way as to protect entrenched interests and assist in the extraction of rents from consumers. That, sadly, would be good for asset prices but bad for the general welfare.
Also of interest is a 2008 New York University working paper which finds that, at least in emerging markets, political risk does a better job explaining financial crises than market contagion.
That is the nub of it: the U.S. and developed markets may start to behave, and to trade, more like emerging markets than their old selves. A bumpy ride is the least we can expect.