Do new government leaders really matter for financial markets?

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Prateek Keshwani's picture

Introduction

At the heart of financial transactions lies a question of confidence. Economists from Smith to Coase have emphasized the importance of confidence, whether to explain the wealth of nations or the birth and death of firms. More recently, Paul Krugman has highlighted the contemporary “games of confidence” that lie behind financial unrest. Given financial requirements and a lack of savings, Asian markets are highly dependent on international capital flows. So what are the important factors that moves the market?

  1. Company News

This can help investors determine the best time to open a position, take their profits or cut their losses. Price movement is affected by supply and demand. But what makes traders want to buy or sell shares? Any significant news from a company will impact interest in its stock. Positive news suggesting growth may see the price rise while losses or bad news could mean a downfall. The company news include quarterly earnings, launching new products, change of management, and a merger or acquisition.

      2.  Sentiments

Another major factor is the market sentiment - The overall feeling investors have about a company’s future performance. This is often psychological. Investors can be influenced by the mood in the markets and what other traders are doing.

      3.  External Factors

The factors mentioned below which are beyond the company’s control can cause market movement:

  • Changes in legislation
  • Public opinion
  • The health of the economy (interest rates, employment figures, house prices)
  • Broader factors like climate change, natural disasters, and conflicts[1]
  • Government transition (including change in leadership)

Now when the government is changing the policy of the government will also be changing. The support of the government for any particular industry or particular sector will also be changing. When the political situation is changing the price movement will also take place as per the changes in the political setup. This change in the financial markets is something that affects the market sentiments. So, the new government leaders do really matter for the financial markets, which can be seen by some of the instances that took place quite recently across some of the Asian markets which rode on a wave of change in leadership of that particular nation.

Modi-fied India

Modi has ridden on a wave of voter support with his message of development, jobs, and revival of an economy-that is growing a decade-low levels[2]. The Indian markets have been on a rally ever since the new government took charge at the center. Some of the key developments, reflecting the change in market sentiments, that took place in the financial markets just after the election results were declared are:

  • India's main stock index SENSEX raised more than 6% to a record above the key 25,000-point level, while the rupee hit an 11-month high.
  • Shares in energy companies and infrastructure, particularly of those whose owners are seen as close to the BJP, climbed.
    Adani Enterprises, controlled by firm BJP supporter Gautam Adani, rose as much as 17 % to 585.00 Rs, whereas Reliance Industries, which is owned by India's richest man, Mukesh Ambani surged by 8.50% to 1,142.50 Rs[3].
  • Banks were also among the top gainers, with Andhra Bank and Canara Bank both gaining 24%.
  • The rupee surged by 1.14 % to 58.62 against the dollar, building on advances that had been fuelled by expectations that Modi would introduce reforms to turn around the economy.
  • The rupee had risen by 17% since sinking to a record low of 68.85 in August, 2013[4] when investors were worried about a fiscal deficit crisis and waning foreign investor confidence as the government struggled to boost growth in the face of global economic turmoil.
  • The stock markets had risen by five % in the week before results as heady optimism had returned despite low investment, and stubbornly high consumer inflation.

                                                            Fig[i] FII Equity Flows

If one looks at about a year ago or even six months ago, there was a sense that the growth upturn may never come and now there is a definite sense that the growth upturn is here and as far as actual change is concerned, we have seen that the first quarter numbers for this fiscal year look up, and the growth outlook is looking good. In terms of the base for higher growth there are 2 things which are considered:

  1. Tangible- The upturn in manufacturing. Manufacturing in India is a small percent of GDP. But, it is the driver of GDP growth. That has indeed turned around from negative to 0 levels last year to 4% in the first quarter this year.
  2. Sentiment & the project clearances – Market sentiment has indeed turned around.

Equity flows rose immediately after the election in response to this expected outcome. So, in this case, a change of leader seems to be a good predictor of flows after the election.

http://media2.intoday.in/indiatoday/images/stories/2014January/2014-1_650_010614110246.jpg

       Fig[ii] Relation Between Political & Financial Markets

Man of the people: Joko Widodo -  Indonesia's new President

During Indonesian Presidential election the correlation between political transition and the asset markets was quite visible in the sense that when the market favored candidate was seen as getting tough competition from his opponent the market started reacting negatively.  The Indonesian stocks and currency were lifted earlier in 2014 by investors who were bullish on a win by Jokowi, who is seen as a more market friendly candidate. However, at one point of time, elections had become too close to call after Jokowi’s lead began to slip in mid-May to just 4 points from as high as over 30 points in the beginning. Investors were concerned that Prabowo’s nationalistic instance, could see policies discouraging for investment and weakening the currency. This was reflected in the pull back in the markets with the rupiah falling around 5% since mid-March to become the worst performer among 24 emerging market currencies. The Jakarta composite index fell down by almost 4% from over 1 year high in May. However, post-election results, the momentum was once again on Jokowi’s side and the Jakarta Benchmark Index surged by more than 2.5%.

http://blogs-images.forbes.com/yunitaong/files/2014/07/dbs2.png

                                                            Fig[iii] JCI Performance

The political certainty of Jokowi’s inauguration and goodwill shown by opposition leaders had contributed to pushing the Jakarta composite index back above the important 5000 mark.

Abenomics & Japan’s Economic Reforms

Mr. Abe is electrifying a nation that had lost faith in its political leaders. The stock market has mounted by 55%, since the time he was elected. Consumer spending pushed up growth in the first quarter to an annualized 3.5%. Shinzo Abe has an approval rating of over 70% (compared with around 30% at the end of his first term)[5]. He is the man to lift Japan over its 20 years long economic comma. He is the one who will go down in history with his name attached to artificial financial stimulus & he certainly got off to a promising start reflecting a boom for the Japanese stock market in 2013 and off course a weakening of the yen by more than 20% against other currencies that helped make Japanese exports cheaper.

http://si.wsj.net/public/resources/images/MI-CG766_JAPANH_16U_20141214170327.jpg

Fig[iv] Nikkei Stock Index Performance

All these factors have helped revive growth in the Japanese economy. The inflation rate in Japan was recorded at 2.40% in November, 2014[6]. Although, Abenomics hasn’t had the desired effect on the Japanese economy in overall, so far, even then the government is determined to put in the necessary effort to revive the Japanese economy and boost consumer confidence.

Conclusion:

The above mentioned examples suggest that the elections have an effect on equity flows only when they create some policy uncertainty. These effects may be due to an ideological change or due to a change of political leader. In the absence of this uncertainty, financial markets do not significantly respond to elections. Financial markets are therefore constantly under speculation about the economic policies that will be pursued following elections[7].

The paradox is that, in spite of such evidences as mentioned in the above examples, only few empirical studies have focused on the links between government transition and financial markets. One explanation might be the difficulty that economists have had in formalizing government transition variables. Another might be the reluctance of sociologists to open the “black box” and explore the social-economics of financial markets. However, the so called second-generation models of crises in considering the optimal government behavior and the political dimensions of economic trade-offs, have begun to introduce political variables in the analysis of financial crises. Eichengreen, Rose and Wyplosz were among the first to address the political dimension of financial crises, and finding close links between exchange-rate unrest and political processes[7].

            The ups and downs of financial variables can be explained by economic fundamentals. But part of the story behind emerging-market financial crises is of self-fulfilling prophecies, risk seeking and risk aversion, and changing perceptions. As it has been emphasized, there are complex interactions between finance and politics, between institutional interactions and individual, and macroeconomic and financial variables[8]. In the end, the name of the game in financial markets is confidence, trust and mistrust.