How to invest in times of political change

Political Change

The last few years have thrown up a series of political surprises. Rank outsiders overturning the odds have become so normal that equity markets have learnt to brace for impact and as a result, those impacts have become more muted.

Political leaders and commentators appear to have accepted that old rules may not hold even if there is little clarity on what the new rules are.

The changing political backdrop is a critical consideration for investors.

Governments are important stakeholders to companies in all sectors. Understanding how their priorities are changing and the implications for future profitability is an important part of our analysis of corporate sustainability.

Most commentary focuses on the immediate implications of each result. However, investors are better served by focusing on the structural lessons hiding beneath the headlines, sound bites and policy aspirations, rather than chasing news flow.

We have identified three key shifts in the political landscape that will outlast the next election cycle or today’s political personalities.

1. Fragmented electorate concerns; political instability

The combination of increased voter discontent and the faster speed with which power moves between parties and leaders creates an increasingly fluid, unstable political environment.

Historically, one or two topics dominated the electorate’s worries but the public’s agenda is widening so that far more topics have a significant influence on a material share of the population.

The result is an increasingly fragmented political environment, spanning a wider range of issues, in which power can migrate quickly from one group to another.

2. Economic challenges continue to build

Balancing the public sector’s books is a key part of government’s job description. Doing so is becoming harder as growth slows, populations age, welfare burdens rise and tax planning becomes more creative.

Tax cuts and spending programs may play well in focus groups but in the long term we are likely to see less of either. Over time, a transfer of costs from public to private accounts appears inevitable.

3. Divergence in business vs. political interests

Since the financial crisis, a business-friendly political backdrop has given way to tensions as social priorities have changed.

Analysis of IPSOS Mori’s historical surveys of social concerns in the UK highlights a shift from issues which broadly support businesses (like creating jobs) to those which present headwinds (like reducing immigration).

Implications for investing in a time of political change

The political shifts unfolding around the world will have significant ramifications for global companies and their investors. We outline four of those implications.

1. Currying political favour will become less rewarding

Political capital may become more of a liability as scepticism of the corporate sector grows, consumers’ political views become more disparate and political leadership becomes more fluid.

Although lobbying spending is typically a small proportion of profits, some industries and companies have established strong relationships and influenced policies in their favour.

The tailwinds those efforts brought may become headwinds going forward. The chart below plots the average levels of spending on lobbying and political contributions in each sector.

Graph: Intensity of lobbying and political contributions by sector2. Adaptability will be key

A more fluid political backdrop raises the importance of adaptability over specific plans. Grounding strategic and investment goals in a specific vision of the world, however well thought-through, is less useful than ensuring business models are flexible to the changes that inevitably lie ahead.

To gauge corporate adaptability, the chart below compares the proportions of sales companies generate from product segments which existed in their business five years earlier.

On average, companies in every industry generate more than three quarters of their sales from well-established business units, but there are sizeable differences across sectors.

Graph: Average share of revenues from divisions which existed five years ago3. Global business models under threat

Globalisation lies at the root of many of the issues that top voters’ concerns.

Opening economies to global trade, capital and migration puts unskilled workers into competition with cheaper labour in emerging economies, cedes policy control to market forces and raises immigration pressures.

The net result for economic growth is invariably positive but with the benefits unevenly concentrated in a minority of the population, democratic politics create a brake to globalisation when too large a share of the population ceases to benefit.

Those industries whose customers are most global, or rely on global supply chains, are likely to be most threatened by moves toward more protectionist attitudes and policies.

Graph: Global sales exposure vs. global cost exposure4. Long term government spending and tax pressures

The need to balance their books eventually creates a constraint within which all governments need to operate.

Across major advanced economies, only Korea and Germany are running government surpluses while six of the G7 countries continue to operate with unsustainable deficits even after years of austerity measures.

A rise in taxation, cuts in government spending or a combination of both are an inevitable feature of future budgets, whatever political party is in power.

Those paying the lowest tax rates face the greatest risks of cost increases, whereas those most reliant on government spending are at the greatest risk of growth pressures.

Graph: Government revenue vs tax exposuresConclusions

We have little to add to questions of how the UK’s Brexit negotiations will be affected by the general election result, whether Macron will succeed in transforming France’s political agenda or what excitement Trump’s next announcement holds.

More important is the direction of political travel and the journey ahead for global industries and their financial prospects.

We have identified several trends we expect to feature on that journey. While the outlook may be getting more complicated, a roadmap that includes those hurdles is becoming more important.


The above article was previously published by Schroders on 11th August 2017