If 2016 has highlighted one thing, it is that politics can take us by surprise. While these unexpected events can spook the markets, sound investment principles will protect investors from panic moves.
A year of surprises
Politics has been hard for investors to ignore in 2016. The confident predictions of pollsters and the received political wisdom were wrong-footed first by the result of the UK’s referendum on membership of the EU and then by the victory of Donald Trump in the US presidential election.
As we head into 2017, pundits are eyeing upcoming elections in Holland in March, in France in May, and the German federal election due later in the year, and wondering what further surprises may be in store.
A week may be a long time in politics, as Harold Wilson famously observed, but it is a very short time in investment
Looking past the short-term froth
A week may be a long time in politics, as Harold Wilson famously observed, but it is a very short time in investment. At Coutts, we focus on macro-economic trends that tend to be driven by deeper forces than short-term political results. While changes in the UK’s relationship with Europe will undoubtedly have an effect on the short-term results of companies, we think those that are positioned to profit from large scale changes could do well.
As long-term investors, we seek to profit from these long-term trends in a considered way. A good business with a product people want will tend to do well regardless of the political movements around them. Undervalued markets have a tendency to spring back over time and investors that hold their nerve do well when they do.
Another way to protect portfolios from political risks is through diversification – not putting all your eggs in one basket. By holding a range of securities, in different territories, a portfolio can be positioned to escape some of the negative consequences of political events. By the same token, it means that portfolios are positioned to take advantage of growth opportunities wherever they should occur.
The past is no guide to the future
As the EU referendum result and Trump’s victory show, trying to second guess political outcomes is not only difficult but very risky. Making a large bet on these results and calling it wrong could well have resulted in substantial losses.
In addition, the after effects of these results can be counter-intuitive. After the EU referendum result, the right tactic was not to sell equities, but to buy them – the FTSE 100 fell sharply immediately after the vote, as investors sold in a panic, but quickly bounced back and has since risen higher than it was before the referendum. Similarly, the FTSE 250 also fell and while it was slower to bounce back has since recouped all its losses.
The market reaction after the victory of Mr Trump was similar, with initial falls in stock markets soon being negated by steady rises that have seen the Dow Jones and S&P 500 hit record levels.
This is not to say that politics can have no effect on markets. Before the US election, US healthcare sold off on the expectation of a Clinton victory after she made it clear that she would take steps to reduce drugs prices and extend Obama care.
As a result, we took a modest position in US healthcare as we felt that whoever won the election markets had over-sold a sector that still offered solid profitability, particularly given the longer-term trend of the aging US population. Trump’s victory saw healthcare rebound substantially, but our decision to invest was not based on the likelihood of who would win – it was based on sound fundamental analysis and a longer-term view that didn’t depend on any particular result in the election.
Sound investment principles can protect investors from investment risk caused by short-term political volatility. Keeping our eye on the deeper macro-economic trends helps us find markets that will reward investors in the long-term. A portfolio that is diversified across territories and asset types means that investors will never be entirely exposed to a single source of risk, nor will they miss out on growth opportunities when they arise.