The Political Impact to the Markets

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The economy functions largely as an autonomous entity dependent on things like consumer spending, manufacturing, interest rates and a slew of other factors. Usually, it’s not too difficult to determine the impact a particular market or event has on the markets, but there’s one risk that tends to be enigmatic to investors – political.

One might think that politics plays a big role in how the economy operates. As such, elections are carefully considered by investors with different segments of the economy expected to be impacted by new policies and changes. And while there’s no argument that politicians can enact new tax laws and other reforms that impact businesses and consumers alike, the actual effect is harder to pinpoint.

Politics in a portfolio

Proper portfolio management includes accounting for risk. Some risks, like interest rates, foreign exchange rates and equity prices can be effectively prepared for and hedged against. Political risk though is harder to plan for.

Elections, despite what the pundits might tell you, are hard to predict. Democrats and Republicans trade positions in Congress and the White House on a regular basis, making it virtually impossible to have a long term strategy for hedging against political risk.

The good news is that politics doesn’t actually play much of a role in the stock market. Investors might buy or sell certain sectors in response to a political event, but those changes are almost always temporary and minimal. A short term rally may occur given the election of a new president, but considering there’s no fundamental reason for the rise, it’s all led by speculative buying.

In truth, the president has very minimal power when it comes to affecting the economy. Despite numerous claims otherwise, the president really can’t do anything directly to change employment numbers, inflation, interest rates or the stock market.

Even certain changes, like Trump’s infrastructure spending plan, is a double edged sword that balances out. There is a short term gain for the markets, but over the long term, more government spending could prove somewhat detrimental to the economy.

The Federal Reserve is sometimes thought of as a political entity, but in truth it operates independently. It has allegiance to no political party with its stated goal of maximizing employment and managing inflation being its only mission. Changes in interest rates are done as an economic tool, not a political one.

The best advice for investors is to tune out any political talk and focus on economic fundamentals instead. The media tends to make news out of almost anything and investors tend overreact to any event. There’s a common saying on Wall Street, “Buy the rumor, sell the news.” In other words, take advantage of short term fluctuations and speculation, but don’t hold out hope that they’ll make any real difference in the long term.