If you have read my blogs for any period of time, you’ll know I often talk about the relationship between the media and the markets, particularly my disdain for the media. I have also been known to talk about the relationship between the markets and politics. With the first primaries of the next presidential election less than six months away and continually increasing tensions between parties in Washington I felt it was time to dispel some myths, detangle the web woven between politics, the markets, and the media, and prepare you to enter election season without a care in the world.
Why? Because you are a long-term investor who knows that no matter what mud gets slung, the markets will always prevail over time.
Let’s start with some basic questions about these groups and their interactions with each other.
Q: How can politics affect the stock market?
A: There are a few ways that politics can affect the markets; however, the effects are indirect - not direct. Fiscal, monetary, and regulatory changes made by the government can affect the bottom line of both corporations and individuals. During election years, investors often watch the political landscape to determine which party may win and how that may affect their investments.
The fact is that elections come with policy changes, and policy changes create winners and losers. During election periods, the markets can act as an indicator of winners and losers because the gains in certain companies and losses in others show us how the markets perceive potential policy changes and their effects on publicly traded companies.
However, perception does not always translate to reality, but that doesn’t mean the insight we gain from the markets during election periods isn’t useful; it just needs to be measured against all factors affecting the markets and then marinated in reality for a while.
Q: How do investors’ beliefs about policy changes appear in the market?
A: Regardless of what is going on in the world, election, media mayhem, or otherwise, the price of a company’s stock reflects investors’ beliefs about its future profitability. In other words, the market is forward-looking, continually assessing the value of a company based on what may happen. What does this mean? This means that the behavior of the market is based as much on feeling as anything else. And you know what they say, “Feelings aren’t facts.”
When a company’s stock rises, this typically indicates that investors believe its prospects are improving. The opposite is also true. If a company’s price declines, it means investors feel that the profitability of the company is questionable. In this sense, the market acts as an information clearinghouse constantly crowning winners and losers based solely on the expected performance of a company.
Q: What makes a loser?
A: Here’s a very simple example. Say a new leader comes into office and appoints new economic advisors and a new chair of the Federal Reserve. Maybe some economic and tax policies have changed. Let’s say they change tax policy for corporations, increasing corporate tax rates. These actions can affect a corporation's bottom line by digging into profits or reducing dollars budgeted for research and development. As a result, corporate earnings may decrease, which can cause investors to question the value of a company, and the stock price may dip lower.
Q: What makes a winner?
A: Let’s say corporate taxes are reduced instead of increased; this means companies have more money to pay dividends or invest in research and development. That is likely to be rewarded by investors.
Q: Where do politics, the media, and the markets intersect?
A: As we know, changes in government policies and regulations can affect a company’s profitability, which in turn can affect its stock price as investors assess the future success of a company. This assessment is usually highly influenced by the media because while investors are looking to the future, they are basing their assessments on present-day news. This means that the media triggers investors to assign present-day value to a stock based on something that may or may not happen. Even if a policy is changed and affects a company in the way investors have “predicted,” it happens well before that policy is actually implemented.
So where do these three roads, politics, the media, and the markets intersect? At Uncertainty Street - and that is where all the trouble lies.
Let me ask you this - If the present-day value of a company is determined based on emotion-infused media reports that lead to feeling-based investor assessments on events that may or may not take place at a point sometime in the future, do they actually matter?
Nope, they certainly do not! Especially not to us long-term investors who know that elections of some kind happen about every two years. This means that basing the value of a company on the bouncing ball of policy, media opinion, and regulatory change is, well, it’s just plain stupid!
Join me next week when we will dig further into that stupidity and its antidote, our good friend fact.
Until next time…
One last thought: I believe an educated investor is an empowered investor. If you like what you’ve read and think your friends and family can benefit as well, please share.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested in directly.
All investing involves risk, including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Dollar-cost averaging involves continuous investment in securities regardless of fluctuation in the price levels of such securities. An investor should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not assure a profit and does not protect against loss in declining markets.