Introduction
A stock market is a complex system which consists of a huge number of investors who make random investment decisions. Therefore, it is very difficult to predict the movement of the market and it is also impossible to explain the market volatility with a specific factor. However, fundamentally, the stock market is influenced by a number of external and uncontrollable factors, including supply and demand, economics, politics, investor sentiment, current events, and company related factors.
In recent years, many countries have experienced drastic changes in the political landscape. The ongoing health crisis—the COVID-19 pandemic, which has led to a global recession, may potentially change politics around the world even further. As a result, the domestic or global political occurrences which raise the level of uncertainty of a country or region has led to increased volatility in the stock market.
Domestically, a general election will raise the political risks in the market due to the uncertainty of the government and policy changes made in the future. As the government is responsible for shaping the business environment and influencing the business operations directly or indirectly through policy making, the risks surrounding the transition of government will drive investors to be more cautious. Internationally, global conflicts such as wars or trade wars which create negative sentiment will also have an effect on the investors, causing heavy selldown in the stock market.
Long-term effect and short-term effect
The stock market consists of short-term and long-term investors which both hold different investment perspectives and rely on different factors for decision making. Short-term trades tend to prioritise and react to technical factors such as inflation, trends, and market sentiment, while long-term investors are more likely to focus on fundamental factors, including business prospects and the long-term impact of the technical factors. Therefore, the impact of political factors on the stock market can be both long-term or/and short-term.
To illustrate, investors may probably react positively or negatively to the election’s outcome based on their expectation after the election day. However, the stock market will return to normal after a few days if the transition process goes well. This situation can be considered a short-term effect. However, a policy change on corporate tax rate will cause a relative long-term effect as it will impact the company’s earnings for years.
Impact of Election on Stock Market
It is widely believed that a country’s general election has a significant impact on the stock market directly or indirectly as it creates uncertainty about the future of the country. Stock markets are generally more volatile and investors are more cautious when elections are coming. Especially during the election years, investors tend to prevent taking aggressive positions until the results of the general election have been confirmed. During the presidential election year of the U.S., it has been proven statistically that investors reduce their funds from the equity market, thereby reducing the risk exposure of their investments.
Typically, the stock market will see an outflow of investors once Parliament has been dissolved, as a consequence of political risks arising from the upcoming election. For instance, following the announcement of Parliament dissolve in March 2018, the FBM KLCI dropped 2.40 points with a turnover of 1.72 billion shares.
Stock Market Reaction After the Election
If the election outcome is unexpected or less expected, the market is more likely to react negatively. This shock will trigger the investors, especially foreign investors, to make capital outflow, rushing out from the stock market to protect their capital. As a result, the stock market will see a huge selldown after the election. For instance, on the first trading day after the 2008 election, FBM KLCI lost 9.5% given that Barisan lost its two-thirds majority in the Parliament for the first time. Similarly, after the unprecedented government transition occurred in the 2018 election, the stock market recorded a huge foreign outflow of a total of US$949 million worth of stock in 11 straight days.
Change of Policy and Regulation
The transition of power raises the investors’ concern over the possible change of policy and regulations such as taxes or interest rates. The government’s business-related policies will shape the business environment in the country and thus affect the businesses’ operations directly. Sometimes, the change of policy will impact the performance of the affected industry. Generally, investors will practice a “wait and see” approach to gauge the policies of the new government. As the outcome of GE14 was unprecedented and unpredictable, there has been massive outflow, especially of foreign funds, in the stock market after the election. Due to the uncertainty about the new federal government’s policy direction, investors choose to remain sidelined and wait for the government’s clarification of future direction such as the removal of the goods and services tax (GST).
Taking the US as an example, according to CFRA’s chief investment strategist, who predicts the US stock market is likely to have a bullish trend regardless of who wins the Presidential Election for different reasons. A democrat win will help the industries materials company as there is likely to be economic stimulus with infrastructure spending, while a Republican president will be able to protect the technology industries as the threat of regulation is dissolved.
Moreover, the corporate tax policy is of significant concern for investors as it will directly affect the company’s net profit. Thus, the implementation of higher corporate tax rates will provide negative sentiment to the market as the company tends to earn less after paying for taxes. To illustrate the impact of tax policy, Donald Trump, the 45th president of the United States, has implemented pro-growth and pro-market policies, including tax cuts to 21% from the previous 35% in 2017. The stock market has reacted positively toward these incentives which lowered corporations’ tax burden, shown by the Dow and S&P 500 hit an all-time high after the announcement is made.
Uncertainty on Continuity of Major Projects and Contracts
The transition of power also raises concerns over the continuity of previous government contracts and projects. Generally, after a new government comes into power, the major projects and contracts that were signed by the previous government will be reviewed and probably terminated if it does not match their mandate. The impact is more likely to be reflected on the particular stock prices that are related to the projects instead of the overall movement of the stock market.
This situation arose after an unexpected win by the Pakatan Harapan in the 14th General Election in which the spotlight was put on the major “China-linked” infrastructure projects and investments such as East Coast Rail Link (ECRL) and KL-Singapore High-Speed Rail. This created a negative sentiment to the construction companies that were involved in these major infrastructure projects. Gamuda Bhd share price fell by 6.05% after the government announced the decision to drop the High-Speed Rail link project.
Moreover, MyEG services Bhd which is well-known as a heavyweight contender for government contracts experienced a huge loss of nearly 65% after GE14. Among the electronic government services it provided, the foreign workers’ insurance and permit renewal are particularly lucrative to the company. Thus, investors are worried about the possible discontinuity of these contracts after the transition of power.
Impact of Global Conflict on Stock Market
With technological advancement, the world has been driven to globalization. However, there are some arguments which claim that globalization may cause more global conflict between different countries or regions. With the rising uncertainty, the stock market generally reacts negatively to the global conflict.
War
It is generally expected that the geopolitical uncertainty will impact the stock market negatively. However, according to a report by CFA Institute in 2013, US large-cap stocks rose and outperformed the average large-cap annual return during World War II, the Korean War and the Gulf War. It also reveals that the volatility of the large-cap stocks is lower during times of war which is 12.8% versus 19%. Although the market saw a positive gain in the long-term, markets do tend to fall on the day of an attack and in the following days. According to LPL Research, geopolitical events previously have caused an average of 1.2% drop in S&P 500 in one trading day after the events and average total drawdown of 5%.
Looking at the recent crisis, the S&P 500 and key Asian market indexes fell after the Middle East tensions arose following the death of general Qasem from Iran who was killed by the United States. With the increase in oil price, Bursa Malaysia’s energy index which reflects the oil and gas related shares’s performance surged 2.9% to it’s all-time high of 1300.83 points.
Trade War
Since early 2018, the world’s two largest economies, the US and China have been “fired” in a trade war due to the trade policy matters. The 2016 presidential campaign was the starting point of this trade war as Trump has focused on the issues of the US trade deficit with China. Since then, the ongoing trade negotiation between these two countries has escalated, following several times of increase in tariff imposed on each other import goods.
This ongoing trade war has impacted all of the global stock markets and heavily impacted the US and China market. Research by Peter Egger and Jiaqing Zhu (2019) discovered that the indirect effects of the trade war on the third economies can be positive or negative, depending on the sector’s and economy’s position in the global value chain.
V.S. Industry is one good example. An electronics manufacturing services company in Malaysia, it has benefited from the trade tension between China and the US through securing the news customers which are relocating their manufacturing base from China to South-East Asia.
Conclusion
In pricing the shares, there are many factors to be taken into consideration as the stock market absorbs a bulk of latest and relevant information and reacts accordingly. With the ability to influence the business environment, the political factors have been seeking the attention of investors.
Given that investors are fearful of uncertainty, as illustrated by political events which seem to have a significant impact on stock market movement. To manage the increased political risk, it is important for investors to understand and keep track of the political conditions and the policy issues that may potentially impact the business environment and stock market.
Researcher: Evon Chew
Reviewer: Millen Lau
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