No Country For Old Men

The ramifications of politics into financial markets

More often than not, I stir well clear of politics, unless it invites itself at the table of capital markets. These days it is hard to escape the political heat, as mentioned in a previous post .

While everybody is busy volunteering an opinion on who wins or loses, I pragmatically notice that most politicians currently in place are dropping one after the other by way of political fatigue. Whether it is Rishi, Joe, or Emmanuel, the polls have them as sure losers in the upcoming elections.

One reason is the traditional switch of the pendulum from one side of the political spectrum to the other, right or left. The other is that our rulers are hard put to find a place in a rapidly changing, and increasingly brutal world.

Is there really no more country for old men? We may see that as a generational issue, where the all-tech moment that we are living through is casting aside boomers of yesteryear who fail to understand and adopt the new thing. Well, not really. First of, the current AI boom is precisely a democratization of artificial intelligence, where even grandma can prompt chatGPT via Siri to generate a quiz of singers of the 50s. Second, some of the politicians dropping like flies are not as old as your common Joe, Sunak and Macron are/were surprisingly young leaders.

There is more certainly a broad crisis of institutions across the Western world. In the US, trust in the Government has melted down over the past 20 years. While Gallup polls in 2003 were showing that 58% were trusting the Government for tackling domestic issues, they were down to 45% in 2013, and only 37% in 2023. Comparatively, small business enjoy much better credibility at 65%.

What should be the impact on markets of such crisis moment? Overall, capital markets have been rather agnostic concerning right or left alternatives, and fared equally under both, even though slightly in favor of Democrats in all honesty.

In the aftermath of the US debate debacle on June 27th, and a clear win for Trump, equities zig-zagged between profit and losses, confirming market’s indecisiveness when it comes to politics.

In a similar fashion, the earth-shattering call for snap elections in France has not led to market mayhem. French 10-year bond spread widened by 50bps against German bunds, far from the 200bps seen during the Eurozone crisis in 2011, and the CAC 40 dropped by a mere 6.5% since the dissolution of Parliament announcement on 10Jun24. Even the euro-dollar remained stubbornly stable at 1.07.

If anything, investors are positioning for opportunistic buying should markets drop further. The main reason is that, while populist parties would further increase deficits, and pile on more debt, it would take more time for the lack of reforms and the further demise of international institutions to result in long-term economic damage.

How should investor position? it is likely that financial mismanagement, and protectionist measures would invariably translate into inflation and result in higher-for-longer rates. In my book, the short-end quality names are a better risk-reward e.g. short-dated US treasuries, short-dated IG corporates, and short-dated German bunds in euro. The market currently buys into the short-end while selling the long-end, as it fears re-steepening.

Regarding equities, I still favor a good dose of US equities, noting that the US economy has shifted in higher gear than the rest of the world. They embarked into turbo-charged investments into the 4th industrial revolution, which is having them well ahead of the pack. This advance shows in pricey valuations, but is still underpinned by superior returns. This has halo effect on other international companies e.g. ASML, TSMC, Novo Nordisk.

At a portfolio level though, I believe that the traditional 60-40 shifts into a 40-40-20 (equity-bonds-alternatives) in the foreseeable future, as higher rates make the returns on fixed income and private credit more attractive in particular. The past 20 years of extremely low interest rates have benefited equity markets disproportionately, and this trend is most probably over. Therefore the return generated by equities, which was ~10% annually in the past, is likely to be closer to 7% over the coming 10 years, on par with more stable bond and credit risk-return profiles.

May markets be with you.

Stay safe out there !

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Sources -

FR centrists are facing a debacle - Economist

How sectors perform under Republicans vs Democrats - JPM