Equities: Geopolitics Is Back.
Which Sectors of the Economy Are Most Vulnerable to Political Uncertainty?
After the election of Donald Trump and the surprising Brexit vote in favour of leaving the EU, investors rediscovered the meaning of political risk. In 2017, the financial markets are being constantly reminded of this risk in view of the succession of major elections coming up, particularly in Europe. The French presidential election is around the corner and in September the Germans will go to the polls. Geopolitical issues are equally a source of concern. This has been particularly true in recent days with the US airstrikes in Syria and escalating tensions with North Korea. In this unclear environment, investors are tempted to take a breather on stock markets and turn to less risky investments. Which sectors of the economy are most vulnerable to political uncertainty? We explore this question.
THE REGULATED: The tightly-regulated sectors are highly sensitive to political decisions. The most regulated sectors are utilities, telecoms, banking and health care. In the US, President Trump plans to relax regulations in the energy, health care and banking sectors. Any news confirming the possibility of more flexible rules would underpin their stock market performance. Nevertheless, investors must follow the developments of the promised reforms. False starts cannot be excluded. Difficulties in passing the laws in Congress, and the implementation of the reforms could concern or disappoint the markets.
THE REFLATIONISTS: The sectors linked to consumption or investment — notably discretionary consumption and industrials — are currently very dependent on the extent of political announcements at the moment. The prospect of tax cuts and infrastructure spending lent considerable support in 2016. Banks, particularly American ones, have also benefitted from this favourable climate, which have encouraged the reflation in the global economy. Today, political leaders must deliver concrete progress. Otherwise, investors could be disappointed. Donald Trump’s recent difficulty to reform the health care system (repeal of Obamacare) does not seem to reassure them on this point.
THE GEOPOLITICAL: The energy sector is obviously sensitive to geopolitical events. For example the US intervention in Syria has put upward pressure on the price of oil per barrel, bringing renewed interest in the majors on the stock markets. The barrel remains above $50, which is excellent news for industry players who can maintain their dividend, thanks to large cash flows. Furthermore, their valuations are cheap.
THE SECULAR: The technology sector seems to have been relatively spared from geopolitical events so far. Albeit known to be particularly vulnerable to the economic climate, this sector has regularly outperformed in recent quarters. So what is its secret? Solid balance sheets, long-term growth, striking innovations and growing needs for technology in every area of the economy (manufacturing, automobile, connected objects, etc.). We see the same enthusiasm for the sector, despite the significant rise in valuation ratios. In the first quarter of 2017, the technology sector was still top of the sector rankings: +12% vs. 6% for a wide American index (+11.5% in Europe vs. 5% for the MSCI Europe). This trend may continue as long as investors remain confident in the improvement of the global economy. In this respect, the future trade policy with the US will be decisive for the sector. The recent meeting between Donald Trump and the Chinese President Xi Jinping was intended to lay the foundations of new trade relations between the two countries. Without revealing anything new about their strategy, the two leaders still set a target of 100 days to find a solution for an equilibrium in the trade balance.