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NN Investment Partners

Clueless: political confusion persists, but growth also resists



Valentijn van Nieuwenhuijzen (Photo: NN Investment Partners)

Valentijn van Nieuwenhuijzen (Photo: NN Investment Partners)

Many of us have been surprised by last year’s political events. Maybe even more have been amazed by the market’s response to the political shock waves. And almost all of us are now lost on how to interpret the eye-catching flow of tweets from US president-elect Trump. And next to all this populism, geopolitical risks and fears over migration, technological disruption and European fragmentation all seem to be building further. The insecurity that this creates in society confuses many and creates a widely shared impression that it is more impossible than ever to foresee what type of negative shocks will hit us in 2017. But negative they will, that seems one of the few things that the consensus amongst economists and political analysts is clear on.   

Does it mean we are now simply clueless on what New Year will bring for markets? If markets were only driven by politics we might be, but one of the crucial lessons from last year is that they are not. A political crisis is something completely different than a financial or economic crisis. Sometimes these types of crises overlap or interact, but they are neither the same nor a mechanical consequence of each other. This is a crucially important awareness that market have and is sometimes missing in the perspective of market commentators, the media or other “specialist” forecasters that inform us on the year to come.

The last decade full of political and economic turmoil provides a nice illustration on the influence of political and policy uncertainty on markets. In the graph above the 5 largest equity markets corrections since 2007 are shown in the shaded areas, of which 3 coincided with high and rising policy uncertainty (as measured by the Baker/Bloom/Davies policy uncertainty index). Important to note here is that there were much more periods in which policy uncertainty was high over this period. However, it was only when the Great Financial Crisis, the Euro crisis and Chinese policy crisis coincided with substantial negative surprises on the economic data front (the grew bars swinging down) that equity market responded very negatively in 2007-09, 2011 and late 2015/early 2016. Moreover, two other periods of negative risk appetite in markets coincided with modest or even falling policy uncertainty as other factors dominated investors’ minds (like a sharp sell-off in global bond markets).

These insights do not necessarily make it easier to forecast how markets will behave, but it does tell you that more things matter than just politics. Also last year thought that lesson very clearly again as the Brexit vote and the US election could not prevent the market from realizing the global economy was actually improving firmly and is heading into the new year in its best state of the last decade. Unemployment rates are at cyclical lows, household and corporate confidence is at cyclical highs and leading indicators for the business cycle are pointing up in a synchronized way across the globe.

Meanwhile, investors remain cash and/or bond rich while those asset classes probably offer the weakest expected returns since the 1930’s and investor sentiment has jumped higher on the back of stronger GDP and earnings growth expectations. And since excessive positioning or contrarian technical signals are no longer visible for most risky assets it made sense to further upgrade our risk tilt by adding to both equities and real estate in recent weeks.

Political risks in the US, France or Italy, more hawkish central banks or renewed emerging market worries are just a few of the risk factors that could potentially force us to adapt again. For the time being however the underlying economy is guiding us towards a growth oriented mindset. And let’s hope also growth can surprise for a change.

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