Investing in an age of political uncertainty
04 December 2017 | Markets and Economy
Despite political surprises like the Brexit vote and the election of President Trump, asset values have done well in the past 18 months. What can investors learn from this?
Market responses can be just as surprising as the political event. Many people would have expected an equity sell-off, but shares have generally rallied. Bond markets have done well too. The big lesson here is to stick with your long-term investment plan. Avoid the temptation to time the market.
An interview with Dr Peter Westaway, chief economist and head of Vanguard Investment Strategy Group, Europe.
The other lesson it reinforces is the importance of diversification. A well-diversified portfolio cushions the blow from these political and economic shocks and any subsequent market sell-off.
What are the current risks facing investors?
On the political side, no matter where you are in Europe, whether it's part of the European Union or not, the rise in anti-EU sentiment is troubling. This could have far-reaching implications in terms of trade between nations and ultimately on economic activity. That said, we could make the case that the tide is turning. Polls indicate that there is more support for remaining in the euro than there was a few years ago.
The challenge for the EU is whether events like Brexit and secession demands in regions such as Catalonia destabilise the union or galvanise politicians to create a more integrated Europe. [President] Macron in France seems to be pursuing the latter course.
A hard landing in China and the end of quantitative easing are the notable economic risks. Slower Chinese growth is to be expected after many years of rapid expansion. The big risk now is rising debt levels there, which makes us question how sustainable growth rates are. The withdrawal of monetary policy stimulus around the world is a big unknown. And it's possible any market reaction could be extreme given how supportive the policies has been for asset prices.
How do these risks play out in your long-term investment outlook?
While normalisation of monetary policy means rising rates, it will still be accommodative. So the new normal for the global economy will be characterised by low interest rates and as a result lower real returns across equities and bonds.
With real returns expected to be lower for longer, what should investors do?
Two things. First, keep costs low. This matters more than ever in a low-return environment. Using low-cost mutual funds and exchange-traded funds can improve your chances of investment success. Second, which we've already touched on, is broad diversification. It's difficult, if not impossible, to position a portfolio so that it can circumvent big political and economic risks. Diversification reduces portfolio volatility, which again can help you achieve your investment objectives.
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