How Much Do Political Events Really Impact Markets?

The metastasizing series of scandals following the Trump administration is heating up to a simmer this evening, as Special Counsel Robert Mueller has announced he is opening an investigation into potential “obstruction of justice” by the Commander in Chief himself.

At times like these, we as investors have to ask ourselves how much weight political events have on markets. It’s tempting to freak out over every new revelation in the Russian collusion case, but first let’s take a step back and look at some history.

Some presidential scandals of comparable caliber over the past half century include the likes of Watergate under the Nixon administration, the Iran-contra Affair under Reagan, and Bill Clinton’s impeachment following indiscretions with Ms. Lewinsky.

Of these, the only one that co-occurred with market instability was the Watergate scandal. A 2013 analysis by Seeking Alpha’s Eric Parnell, though, makes a convincing case that even that bear market was caused by the abandonment of the Bretton Woods system of monetary management and later by the 1973 OPEC oil embargo that drove “stagflation” throughout the 70’s.

So presidential scandals don’t have much of a history of traumatizing markets. Yet it’s clearly not true that politics never affects markets.

Elections, the Brexit vote, monetary policy changes, all of these have visibly felt effects on the market. In the days following the shocking outcome of the Brexit referendum, for instance, the British pound fell roughly 14% against the dollar. According to a 2006 study, the outcome of the 2000 election had the effect of transferring $100 billion in market capitalization from firms that would benefit from a Gore presidency to those that would benefit from another Bush.

Even the Trump scandal has had some effects on finance. Less than a month ago on May 17, following the announcement that a special counsel was being brought on to investigate Russian interference in the 2016 campaign, the American stock market went into a brief panic and the S&P 500 saw its biggest decline in months.

But comparing the sequence of scandalous events with the ticker of the VIX, “Wall Street’s Fear Index,” it’s plain that no other political development has made such significant waves. Why did the appointment of a special counsel in particular have such deeply felt effects?

As I wrote about at the time, analyst consensus was that mounting an investigation into Russian interference and collusion was looking likely to take a front seat at the expense of passing tax reform legislation that investors were so eagerly anticipating from the Republican-dominated federal government.

Indeed, that’s what made all the difference. As callous as it sounds, what gets investors to care is when money – lending, taxes, or trade – is involved.

That’s why Brexit was such a financial atom bomb – if the U.K. leaves the European Single Market, that will stymie the flow of goods, capital, labor, and services between Britain and the continent, reversing many of the economic benefits of free trade and crippling many companies that rely on imports and exports with Europe.

With that in mind, it’s hard to see how findings that Trump or his staff were or weren’t naughty will directly bear on markets. Regardless of what happens to the executive branch, the legislative branch will be held until 2020 by Republicans bent on tax cuts.

There are a couple of ways that the ongoing investigation could indirectly affects markets, though:

  • It affects the timing of resuming business as usual.

Investors want the government to get back to passing laws, and if it becomes clear that Trump will resign, be removed from office, or be acquitted, and that the American political sphere can put this scandal behind them, we could see a bump.

  • It affects the probable outcome of the 2020 midterms.

Markets like Republicans. As a center-lefty myself, that puts me in an awkward position when rooting against my portfolio, but such is life. If distaste among voters for Trump translates into eroding support for the Republican candidates in 2020, markets are likely to get upset.

So given these cues, I think what’s to watch is how quickly Robert Mueller’s investigation proceeds, and how the public reacts. The best case scenario for portfolios is that Trump’s name gets cleared, and quickly. If the matter drags out, looks ugly, and reflects poorly on Trump and everyone else ensnared in its sticky web, we could be in for a rocky time period.

My bet, at least, is that it won’t be quick. Federal investigations take a loooong time, and this seems to be a case that gets deeper and messier with every passing month. I’d buckle up and get ready for a politically unsightly, but economically stable, couple of years ahead.

-Conor

Photo credit to Gage Skidmore.

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