Despite almost non-stop news coverage of the high likelihood and adverse implications of a US government shutdown, the performance of stocks and bonds in recent days betrayed little evidence of investor concern. Go back a little further and markets have shown a striking ability to shrug off political and geopolitical instability.
Is it luck or do markets have a better handle on these issues than most experts? In the last few years, investors have essentially ignored expert advice about a long list of political and geopolitical issues. They include what turned out to be misplaced warnings.
In sum, these developments haven’t derailed global growth and corporate profits, neither individually nor collectively. Instead, investors and traders have been validated, confounding the predictions of many political scientists who have many more years of study and experience of politics and geopolitics.
Some may be tempted to argue that pure luck could have played a role in the good market outcome. But there are too many incidents for this to be a compelling explanation. Indeed, a better one may lie in a combination of the following:
Markets’ narrower focus
Unlike political scientists, markets focus on what disrupts a handful of specified risk factors, and do so with a considerably shorter time horizon. They also deal with what can be reasonably priced, leaving other issues — such as the probability of whether an irrational North Korea will decide to translate nuclear threats into action — mostly to the side.
Neighbourhood effects
Investors have taken considerable comfort from a generally supportive economic and market environment that includes an encouraging synchronised pickup in global growth, improved prospects for additional pro-growth policies, ample liquidity and high risk tolerance. With these factors in play, it takes a big shock, or a rapid accumulation of small ones, to dislodge market sentiment.
Backstop
The markets’ willingness and ability to look beyond immediate threats have been bolstered by the perception of considerable funding assurances from two sources. First, from central banks through the recent (repeated) history of comforting policy guidance and large-scale asset purchase programmes that have turned these institutions into BFFs for many investors.
Second, from cash-rich corporate balance-sheets that encourage stock buy-backs and higher dividend payments.
Political scientists can rest easier in the knowledge that markets don’t necessarily know their business better, but — rather — benefit from a combination of a narrower focus, a favourable context and a deep belief in a strong backstop. Political scientists should take these factors more into account when seeking to translate their political/geopolitical insights into market calls.
Meanwhile, rather than completely dismiss what these experts have to say, investors should realise that it’s a question of a balance, which could evolve over time.
I experienced that latter directly almost 20 years ago when I transitioned from a policy/economic analysis role at the International Monetary Fund in Washington to a more market-oriented one, initially at Salmon Smith Barney in London. There were days when my astute colleagues trading the various markets would be keen to hear from me, betting that my insights would play out in price action.
But there were also days when they would ask me to “come back later”, betting that whatever I had to say would simply be overwhelmed by market technicals.
The writer is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. His books include “The Only Game in Town” and “When Markets Collide”.
