OCBC OneWealth App– Politics: Driver or passenger?

Economics

Global

Outlook

Vasu Menon

Executive Director, Investment Strategy, Wealth Management Singapore, OCBC Bank

Politics: Driver or passenger?

23 January 2020

In brief

Politics seldom have lasting impact on markets unless it materially affects the economic outlook.
Investors should bear in mind two political developments which may trigger a rise in market volatility in the second half of the year – the US Presidential elections in November and Brexit trade talks which must conclude by end 2020. Both can have a material impact on the market outlook in the medium-term.
Markets could become choppier on the back of these political risks. Nevertheless, volatility can throw up good opportunities to enter the market. Investors should tread carefully and stay diversified across asset classes, regions and over time.

Looking beyond the political noise

One thing is clear from recent negative geopolitical developments like the US-Iran conflict at the start of 2020 and the attack on Saudi Arabia’s key oil facilities last September - they rattled investors’ nerves in the short term and weighed on stock markets.

However, markets rebounded soon after, as investors looked beyond these political developments and refocused on the economic and earnings outlook which remained sanguine.

War and peace in a matter of days

In the case of the US-Iran conflict, Iran’s response to the killing of its top military general was eagerly awaited by the markets. There were fears that Iran might launch heavy military attacks on US assets and citizens in the Middle East or even block traffic along the Strait of Hormuz, hence disrupting oil supplies. In a bid to pre-emptively temper Iran’s response, President Donald Trump threatened to attack 52 Iranian sites if Iran dared to respond aggressively.

Thankfully, the Iranian response was somewhat restrained and the impact on the global economy was deemed insignificant. Markets regained their footing after experiencing a short period of volatility.

One could make the case that the Iranians were well aware that the US had the means to inflict significant military damage should they respond disproportionately. Also, considering that this is an election year, President Trump could adopt an overtly aggressive position in response to aggressive attacks by Iran, to play up his strong man image.

A cap on oil prices

Typically, geopolitical concerns in the Middle East would impact the economic outlook by way of higher oil prices. A particular saving grace for the markets this time around is that US shale oil producers have become major players in the global oil market. This is unlike the 1970s, 1980s and 1990s, when the Middle East dominated oil supply. A sharp knee-jerk increase in prices could trigger a significant rise in US shale oil output which would then cap the increase in the price of crude and therefore limit the economic fallout.

To be sure, US-Iran tensions and other frictions in the Middle East pose some risk to the market outlook. But we doubt this would be a major problem in the long-term.

History has shown that such political developments only create a lasting problem if they triggered significant economic fallout. In the absence of such economic impact, markets will likely regain their footing after a short period of turbulence.

Also, policy makers in major economies have been quick footed in dealing with potential economic problems by easing monetary and fiscal policies. This policy backstop will likely limit the market fallout.

Of elections and lurking Brexit concerns

Looking ahead, investors should not let their guard down altogether. While politics is not a material driver for market returns over the long-term, it might prove to be an unruly passenger that disrupts the journey time and again. In this regard, politics could still contribute to market volatility in 2020, especially in the second half of this year.

Two political developments are worth bearing in mind – the US Presidential elections in November and Brexit trade talks, which need to be concluded by end-2020. Both could leave a material mark on the global economy and therefore can impact the medium-term market outlook.

It also remains to be seen if the US-China Phase One trade deal can withstand the test of time. The deal has reduced market anxieties but unless it bears fruit for US framers and the US economy at large, tensions could flare up once again between the two economic giants.

Also, Phase Two trade talks which could start soon, will be trickier as it will involve more complex and deep-seated structural issues between the US and China which are more difficult to resolve.

Brace yourself

As a result, the recent market quiet might not be long-lasting. Markets could become choppier in the second half of this year on the back of potentially adverse political developments in the US and UK. Investors will need to brace themselves for the rise in market volatility.

Still, volatility can also throw up good opportunities to enter the market. The key is to tread carefully by investing sensibly and managing risk by staying diversified across asset classes, regions and over time.

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