What might the future hold for markets?
Political risks can throw the economy off track
Investors continue to grapple with the question of whether further economic slowdown and possibly a recession is coming, or whether the current economic cycle can be extended. Clearly, central banks are trying to engineer an extension. However, politics might throw a spanner in the works. In this respect, a potential trade war is the key issue to track. However, we are also seeing escalating tensions between the US and Iran, which could result in conflict. Closer to home, the EU-Italian budget disagreement, Brexit and a possible Corbyn government in the UK cloud the outlook.
The common theme is that politics can be negative for economic growth, which then impacts ‘risk-on’ assets such as equities and credit. The materialisation of political risk is generally positive for bonds. The possible exception is the impact of a Corbyn government on Gilts. In that scenario, we would expect a fall in Sterling and a fiscal stimulus causing inflation to rise. This could more than offset any fall in yields coming from a flight to safety.
Of course, one can assume that politicians are rational after all. Many of these issues were part of the G20 discussions in Osaka and at least a truce has been reached for US-Chinese trade. But in truth, investors must be prepared for bad outcomes as it is unlikely that politics will take a back seat for long.
What to do? First of all, we would advocate quite a defensive positioning – holding plenty of bonds in case world growth deteriorates, but combining it with protected equity that can benefit if politicians choose a market friendly outcome. Oil can also act as a useful hedge against escalating tensions in the Middle East. Sometimes it is possible to avoid risks all together – with an uncertain Brexit outcome and the risk of a Corbyn government, it might be best not to invest in the UK at all.