Why do global equity markets ignore political shocks like Brexit, President Trump’s election or the news that Angela Merkel failed to form a government in Germany? There are plenty of good reasons, actually, which we review below.
News that German Chancellor Angela Merkel failed to form a new government was the big shock of the day. It is unclear if the country will have a minority coalition or call fresh snap elections. The New York Times quoted a Der Spiegel deputy bureau head as saying “This is Germany’s Brexit moment, its Trump moment”.
Capital markets agreed with the Trump/Brexit comparison, sending the DAX up 0.5% on the day. Every other major European bourse closed in the green as well. As did the US.
All of this got us thinking (again) about why stock markets ignore politics and government when it comes to “Crisis moments”. It wasn’t too hard to come up with several explanations.
Reason #1: The Brexit vote and Trump election are fresh in investors’ minds, and they feel they know the “Crisis playbook” well at this point. Buy any notionally negative political headline first, look for the silver linings later. Muscle memory is a powerful behavioral force.
Reason #2: Global equities remain in rally mode, with investors still more afraid of missing out than looking for reasons to sell. Every major global index (S&P, EAFE, Emerging Markets) is either at or near their one-year highs. And with just a few more weeks left in the year, plenty of investors are playing catch up to their ever-rising benchmarks.
Reason #3: US corporate earnings still enjoy positive momentum. With Q3 earnings season almost over, FactSet reports that the most recent quarter showed 6.2% earnings growth. The companies of the S&P 500 even managed to show a little margin expansion (10 bp) in the quarter, and Q4 estimates still show a 10% bottom line growth rate.
Reason #4: Any political crisis is a potential catalyst for central banks (especially the ECB in the case of today’s headlines) to remain accommodative, with Eurozone QE supporting ultra-low long term interest rates and equity valuations. German 10 Year Bunds still yield just 36 basis points, well off their July highs of 60bp. Today’s news was worth all of 0.3 bp to the German yield curve.
Reason #5: Consumer confidence is still good across the US and Europe. Markets rightly feel that any “Crisis” that leaves consumer sentiment untouched is no crisis at all. OECD data on German confidence shows it at one-year highs as of October after drifting lower in prior months.
Reason #6: Energy prices are still moderate. The one sort of crisis that gets investor attention ties headline-worthy events to the price of gasoline. Despite rumblings out of the Middle East, WTI crude prices are still comfortably below $60/barrel.
Reason #7: Tech stocks have driven a lot of the performance in large cap US and EM this year, and this sector enjoys strong secular tailwinds. As we have outlined in prior reports, the Technology sector represents 25% of the S&P 500 by weighting, and 30% of the MSCI Emerging Markets Index. Neither the US President nor the German Chancellor (or any other global leader we can think of) have any impact on how many people stream videos, use social media, shop online, or buy new smart phones.
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Now, does all this mean global markets will remain impervious to political headlines? Of course not. A few thoughts on what might shift the market’s sentiment:
Real Crisis #1: An absence of global leadership on tough geopolitical problems. With Angela Merkel sidelined, Europe has no single political figure to guide the region’s policy on global issues. President Trump, while still popular with his base, is a divisive figure abroad. China’s President Xi is trying to step into the role of a truly global leader, but that’s a tall ask when it comes to American or European democratic sensibilities.
So who is in charge when if/when a geopolitical crisis arises? For the moment, this is not a question investors seem to ponder much. That doesn’t mean it’s not important. It’s just not important right now. Once North Korea/Iran/some other problem gets to a boil, things will be different.
Real Crisis #2: Political fissures can swallow up positive catalysts. As we outlined in yesterday’s note, the Democrats may be able to retake the majority in the House during midterm elections. That makes passage of tax reform in the current Congress an imperative for US equity markets. Past November 2018, Washington may be back in gridlock mode until January 2020.
Summing up, there are plenty of reasons why notional “Crises” have so little effect on global equity prices. Overall economic conditions are still good enough to spur profit growth, and interest rates remain low. Yes, things seem brittle on the political front everywhere from Stuttgart to Seattle. But until a real crisis comes along to break investor confidence, it is hard to see global equities letting any crisis go to waste