Markets don’t follow the script

Markets can move quickly in response to political news, as we saw following the US midterm elections, when investors reacted positively to the prospect of greater political gridlock and potentially more constraints on some of President Trump’s policies. Trump’s more conciliatory response to the result also appeared to reassure investors, contributing to an improvement in market sentiment.

This is a useful reminder that markets are constantly looking ahead and reassessing what might happen next, with expectations around politics, interest rates, inflation, economic growth and government policy all influencing prices. However, while an election result or political announcement can have a significant short-term impact, it does not necessarily tell us much about the long-term prospects for investors.

Why the economy isn’t the stock market

The same principle can be applied to the UK. It is easy to assume that a gloomy outlook for the UK economy must translate into a gloomy outlook for UK investments, but the two are not the same thing.

Many of the largest companies listed on the UK stock market are international businesses generating substantial amounts of their revenue overseas, suggesting investing in the UK market does not necessarily mean investing in the fortunes of the UK economy.

This becomes particularly important when sentiment towards a country, government or market is weak, because prices can fall as investors become more pessimistic even though the long-term prospects of the underlying businesses may not have changed to the same extent. For long-term investors, this disconnect between sentiment, price and underlying value can potentially create opportunities.

Looking beyond the headlines

At Equilibrium, we don’t believe successful investing is about trying to predict the next election result, reacting to every political announcement or simply investing in whatever has performed best recently. Instead, we look forward and consider the returns we believe different asset classes are likely to deliver, with valuations playing an important role because the price paid for an investment can have a significant bearing on the return ultimately received.

This can sometimes mean looking for opportunities in areas where other investors are pessimistic, but we would never build a portfolio around one particular market, political outcome or economic forecast. Asset allocation sits at the heart of our investment process, with portfolios diversified across different asset classes, regions and strategies. We adjust these allocations as market conditions change and when valuations present attractive opportunities. Portfolios are continually monitored and rebalanced rather than simply being left to drift. Our dedicated six-strong Investment Team constantly reviews both the portfolios and wider investment landscape, looking for new opportunities while identifying and addressing potential risks. This collaborative approach encourages healthy debate, challenges assumptions and ensures a range of views and potential outcomes are considered before investment decisions are made.

Planning for the unexpected

An equally important part of our approach is considering what happens if our expectations prove to be wrong. Markets are unpredictable, political events can surprise and economies can develop very differently to forecasts, so diversification plays a crucial role in allowing us to pursue opportunities while managing the potential impact when things don’t go as expected. It’s a principle we explore in greater depth through our Investor Safety Briefing Experience and Masterclass, hosted by Portfolio Manager Harry Topping, which looks at how we seek to protect portfolios while continuing to pursue long-term returns.

The reaction to the US midterms and the debate surrounding the UK stock market both illustrate this point. A challenging economy does not automatically make its stock market unattractive, just as a favourable political development does not automatically make a market a good long-term investment.

For us, the more important questions are what are we buying, what price are we paying, what return do we expect and what role does that investment play within the wider portfolio? By focusing on those fundamentals rather than becoming distracted by short-term headlines, we can concentrate on building diversified portfolios around our clients’ long-term objectives and the level of risk required to achieve them.