By David Thomson

With the turmoil in UK politics following the recent resignation of Boris Johnson investors may be wondering just how much of an effect politics has on investment markets. Politics has always had the potential to impact the stock market because political actions like regulation and taxes effect companies and thus their fundamental performance. In addition, politicians appoint economic advisors and fill positions at Central Banks which control interest rates that exert an effect on companies and the stock market. There are also geopolitical risks such as the Russian invasion of Ukraine. However politics is generally an indirect effect rather than a direct one.

One thing the stock market detest is uncertainty or political instability. Stock markets like politics to be predictable albeit political events are amongst the most difficult to predict. The Brexit referendum vote certainly came as a surprise to investors with sharp swings particularly in the commercial property and currency markets. A surprise, like Brexit, can cause the stock market to react short term, as the new news becomes factored in. However, once it is, the market often quickly resumes trading on the fundamentals.

Political risk can come from a variety of sources, such as policy decisions and shifts affecting trade tariffs, taxes, labour conditions, privatisation and regulation. political leadership changes, as we are currently seeing in Westminster and government instability. Political volatility and uncertainty stemming from terrorism, riots, coups or war. Political events or sudden policy shifts can disrupt a company’s ability to execute its chosen strategy and ability to cost effectively deliver its products or services. In turn, this can affect company performance and profitability. The effects can of course be both negative or positive. For example, a change in a country’s tax structure, minimum wage or regulatory requirements could raise costs and, depending on a company’s ability to pass those higher costs on to consumers, have an unanticipated impact on earnings. Conversely deregulation or relaxation of trade agreements could be positive for companies.

In the UK, the stock market tends to prefer a Conservative government over a Labour one. According to Thisismoney who analysed performance statistics dating back to 1970 the UK stock market has performed approximately twice as well under a Conservative government as it has under Labour. Although the ideology of a political party does change, the fundamental beliefs of major parties tend to remain the same. Conservatives believe in free markets and capitalism and are therefore regarded as the party for business, while Labour leans more toward socialism and workers unions, which generally are less favoured by business. However, the facts behind the raw numbers suggest events taking place on the global stage are far more important to the UK stock market than the next resident of Number 10, Downing Street.

Ultimately, markets are driven by many more factors than just politics. The stock market is influenced by everything that is happening in the world, so the impact of elections and politics in general is limited. It is hard to pin down the precise effect of politics as the market is simultaneously reacting to the multitude of other events. For example, is a decline in the market being driven by the uncertainty over a political vacuum, fears of a recession, or because there is a cost of living crisis brewing? The economy, and therefore businesses and markets, keep ticking along regardless of what’s happening in Westminster. Politics certainly influences the market, but so does everything else. Accordingly, the UK stock market barely flinched when Boris Johnson tendered his resignation as leader of the Conservative party.

David Thomson is chief investment officer at VWM Wealth