It is hard to keep up. And it is hard to ignore. Politics are far from the only thing of importance for our lives, the economy we work in or the markets that drive our investment returns. And still, our emotional impulses almost force us to follow what happens in the political arena and our mind automatically paints a picture of what this might mean for the future. Those of us who understand well how we think, who appreciate the complexity of the way we take decisions, will aim to mitigate the influence of an emotional response to the latest political newsflash.
They will realise that we are very likely to exaggerate the importance of the political drama. The rest of us, however, are very likely to give substantial weight to the latest political act. If this is done for pure consumption of entertainment or as inspiration for heated political debates; it does little harm and can even sharpen our perspectives on the future.
However, if social, economic or investment decisions start to be steered by the emotions that the latest political fireworks generate, we are likely to make erratic and inconsistent choices that respond more to noise than to informative signals. This is not to say that politics and its possible consequences for socio-economic policy setting can never be important, but it is crucial to appreciate that the way politics translate into policy is not always best understood by listening to whoever makes most noise in the news media or on twitter.
Moreover, how changes to policy will shape the future landscape we operate in is hard to credibly assess without also mapping how other driving forces of that future are evolving. Last year’s Brexit referendum and the Trump election are important lessons in this respect; as the political uncertainty that these events created did not create the negative impact on the economy or global financial markets that most pundits expected. Basically, the headwinds from political uncertainty was more than counter-balanced by the surprising strength of the recovery of the global economy and its positive read-through for labour markets, global trade and corporate profits.
Obviously this does not give us the luxury to ignore politics either. Trump and Brexit can still be a force of influence, just not the only ones. The Credit and Euro crises also have provided clear examples where politics and policy had a major role to play on how our economic reality evolved in 2008-09 and between 2010 and 2013. It is just very important to understand there is always a delicate balancing act at play between different pulses stemming from politics, policy, sentiment of the crowds and economic fundamentals that create the world of tomorrow.
For investors this means looking at all these factors, and continuously assessing how to balance them to best, is needed to estimate the most probable direction of markets in the future. Part of the decision process that might lead to the most robust insights is to adhere to some simple cognitive rules that allow you to better mitigate the emotional temptation to follow the fear and joy that are generated in the political theatre. A rudimental example of this is to cross check the amount of political uncertainty with the direction of the business cycle before making investment decisions. In the aftermath of the Lehman bankruptcy and the start of the Euro crisis, economic data started to weaken sharply and these forces jointly helped to push down markets. After both Brexit and the Trump election, economic activity strengthened and markets responded much more constructively. A political crisis is not necessarily an economic crisis. And if it is not, markets are far less impressed by political noise.
The noise will stay however. Whether it is the over-hyped Dutch elections, the unusual G20 Summit, ongoing Trump tweets (which were partially contradicted by Congressional hearings of the US intelligence community), new North Korean rocket launches, the official trigger of the Brexit talks between the UK and the EU or the first French Presidential debate, it always is important to filter the news flow and assess what the most probable policy implications will be in reality. And then, to create a full picture of what is going on, add the ongoing good news show on the global economy and the corporate earnings to the equation.
And even then the picture is not complete for an investor. Markets are an organism of itself and sometimes it is not so much the response to political or economic news, but much more the intrinsic behaviour characteristics of market participants that explain the direction of markets. The recent correction in equity markets is probably a good example of this as sentiment, positioning and unbalanced derivate exposures had started to hint of short-term correction risks.