A record year for national elections – of no less than 50 globally – naturally brings around-the-clock coverage of campaigns, soundbites and even attempted assassinations on a presidential candidate across newsrooms and just about every social media app, podcast and TV show. Amid a sea of information, Tony Finding sits down with Romil Patel to explain what matters from an investor’s perspective in order to avoid getting caught in the noise while identifying and capitalising on market dislocation opportunities as they arise.
A single election rarely modifies the trajectory of the global economy in a drastic way. Therefore, the importance of election outcomes to investors is inherently linked to changes around the fundamental way that societies and economies are structured. In other words, investors seek to track the evolution of the economic fundamentals that serve to anchor asset returns over a long-term time horizon.
Tony Finding, Fund Manager on the Episode Allocation and Episode Growth strategies, identifies three specific key variables here: the impact on and behaviour of inflation, profits and real interest rates. “If it doesn’t impact those three on a sustained basis then it ought to just be short run volatility,” he says. “Any measures that go after profits aggressively and anything that takes a risk with inflation is much more likely to then be durable, which means the election is likely to matter to investors. But those longer-term trends really haven’t been altered by election outcomes in recent years, in our view.
“We try and keep a sense of focus on what ultimately matters – those three factors, but we also stress that how markets are priced to begin with matters.”
Free and fair elections are akin to oxygen for a healthy and functioning democracy, but it can take a number of election cycles before voter appetite for change culminates in a new governing party. Prior to the current UK government under Sir Keir Starmer, the Conservative Party held power for 14 years after succeeding the previous Labour administrations of Tony Blair and Gordon Brown (13 years collectively).
Beware of the disciplinary forces
The mega-consequences of the 2022 Liz Truss ‘mini-budget’ which triggered gilt market mayhem and cemented an ultimately short tenure as prime minister demonstrates how a slightly more radical policy can cause market dislocations that actually provide real-time feedback which serves almost as a disciplinary force to the politicians of today.
“I think a lot of the lessons learned from the volatility in the gilt market will be acting as a constraint on the Labour Party in terms of how much leeway they have to do anything particularly radical,” says Finding.
“For our investment process, we try and be as dispassionate as possible and the challenge with elections are that they’re generally highly emotive affairs, and it’s important that we remain detached.”
“In the case of the UK, investors quite rightly have taken it with a high degree of comfort that nothing material is going to change. Yes, there will be some areas of taxation that are almost certainly going to change, but really in terms of how society is set up and structured and those broad incentive structures, very little is actually going to change.”
For Finding, looking at those incentive structures – the operational independence of the Bank of England around issues such as inflation, and the ability of non-elected people to operate some of those tools in pursuit of their own mandate – remains largely the same.
Trump vs central bank independence
The most closely-watched democratic election of 2024 is unsurprisingly the race for the White House – as well as Congress, comprising the House of Representatives (with all 435 seats up for election) and Senate (33 seats up for election).
While the news headlines have been dominated by the Democratic Party presidential nominee, an attempted assassination of the Republican Party nominee and the economy among other issues, investors will be closely monitoring the three key variables – behaviour of inflation, impact on profits and real interest rates – particularly in the case of a Trump 2.0 presidency. The context? Central bank independence free from political influence.
“Trump has been particularly vocal around the operation of the US Federal Reserve (Fed),” Finding reflects. “How much scope he would have to materially change that is up for debate but if you start attacking some of those fundamental institutions that are an intrinsic part of society, that would be very important for investors in US assets, especially for fixed income if that affects the medium-term inflation outcomes.”
“Whether Trump 2.0 would cause significant volatility will depend on how much of his rhetoric actually changes policy direction. While Trump has been very vocal about wanting a weaker dollar, the general consensus amongst economists is that the introduction of a load of tariffs would actually lead to a strong dollar. Therefore, how all of this would actually manifest itself is extremely interesting.”
Capitalising on market dislocations
Investment opportunities can arise if the market overreacts to unexpected outcomes. Mexico held elections in June 2024 and while a Claudia Sheinbaum victory to become the country’s first female president was anticipated, the scale of her landslide victory took markets by surprise.
“The financial markets decided they really didn’t like the sheer gains of the ruling Morena Party so they dropped sharply on fears that Claudia Sheinbaum could have the legislative support to pass less market-friendly measures, such as judicial reform for example,” says Finding. “This is quite interesting because the party has got a popular mandate, it’s been perceived as pro-markets and produced some good economic outcomes. Mexican assets, particularly the peso have performed very well over the last few years and then it takes a knock by the size of the majority after the election.
“For our investment process, we try and be as dispassionate as possible and the challenge with elections are that they’re generally highly emotive affairs, and it’s important that we remain detached.”
Interestingly, the feedback loop of financial markets in Mexico was similar to the Liz Truss episode in the UK. The message from the market was: “Hang on, we need to be careful about how we go about this because we don’t want to be changing the broader incentive structures that have caused good economic outcomes in Mexico.”
Disciplinary market forces are generally a good thing – and we could see these powers at play once more if the fiscal situation in the US spirals out of control.
Whilst it is the case that many forces beyond the electoral cycle influence the outcomes for investors and beyond the short run volatility associated with election noise, the extent to which elections really matter for longer-term outcomes of financial markets is still up for debate.
The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.