Date
17 November 2017
Political shocks so far have not materially affected underlying economic activity. Photo: Reuters
Political shocks so far have not materially affected underlying economic activity. Photo: Reuters

Political uncertainty not affecting economic activity

One question I am often asked by investors is – how can stock markets make new highs when there is so much political uncertainty in the world?

On the whole, markets are coping rather well with all the events which have recently made the headlines – this year global equities have risen about 15 percent.

The brief explanation is that political shocks can certainly affect capital flows but – so far – have not materially affected underlying economic activity.

The fallout from Brexit on UK investment and business confidence is an exception, and the situation in North Korea is potentially highly dangerous for Asia. Otherwise, economists are busy raising their forecasts for global economic growth in 2018. We are witnessing a breadth of activity across the three main regions – North America, China and Asia, and Europe – for the first time since the global financial crisis.

Our economists and equity fund managers are looking very closely at the state of capital spending, demand for new loans and the willingness of banking systems to respond in some parts of the world.

It must be said that a recovery of this nature also has the makings of a slowdown in company profits growth into 2018 – as wages and borrowing costs rise, for example. Nevertheless, global cash flow growth still looks positive into 2018.

A job for investors is considering where capital is being invested. Of course, valuations play a part but so does sentiment, and hence political risks; a clear example would be the adverse market reaction to the constitutional crisis in Spain.

Over the summer we carried out a useful research project on the various drivers of global capital flows in both emerging and developed economies.

The direction of the US dollar in coming months might summarise our thinking rather well. The dollar moved from 1.04 to 1.20 versus the euro between January and September.

Its rebound since then has partly been driven by fundamentals – prospects for a US rate hike in December and especially by signs that despite the US political divide there could be US$1 trillion to US$2 trillion of tax cuts supporting US businesses and households — but also a reappraisal of European political prospects – the German election result, pushback against France’s Emmanuel Macron, even before the results of the Austrian and Italian elections.

The dollar’s rise will stop when the good US and bad European news is in the price.

– Contact us at [email protected]

RT/RA

Head of Global Strategy, Aberdeen Standard Investments

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