At Devon we consider investments using a “bottom up” approach – that is, we focus on individual stocks and take views on their individual attributes and earnings to decide whether to invest in them.
Our portfolios are constructed by aggregating together our preferred stocks. We use this approach because we take the view that ultimately quality and value will win out. This approach is considered “active” portfolio management and as such our portfolios typically do not follow the performance of underlying indexes.
This means that there will be periods where we outperform and periods where we underperform our benchmarks.
While we are strongly of the view that this is the appropriate investment method over the medium to long-term, it would be naïve to assume that financial markets are always driven by company fundamentals on a short-term basis.
Very frequently significant macro economic and political events will drive markets as a whole in one direction or another, often when the potential implications of such events are very unclear. Usually the impact of these events is reasonably short lived but it behoves us to nevertheless be aware of potential risks.
After a tumultuous year in politics in 2016 one could be forgiven for hoping that 2017 would offer a more benign outlook. While it is true that there is (thankfully) no US presidential election on the calendar, or a referendum with implications as large as the UK’s decision on whether or not to remain in the European Union, there are 3 elections that each have the potential to significantly impact financial markets.
Europe is the scene for two of them – the French presidential election and the German federal election.
The French election is the nearest with the first round being held on the 23rd April. The focus of much of the attention has been on the strong showing in opinion polls of the candidate from the far-right, anti-immigration, anti- EU National Front, Marine Le Pen.
As at the end of January she was the highest polling candidate, though with the field reasonably crowded in the first-round, only 25% of respondents have indicated their intention to vote for her.
Their election follows a multi round process until one of the candidates achieves an absolute majority.
The National Front’s fervent base of support makes it likely that Le Pen will generate enough votes in the initial stage to be one of the two participants in the final round but the key question is whether or not she is able to entice enough voters from outside her core support to win overall.
On the only prior occasion that the candidate from the National Front has contested the final round of a presidential election (Marine Le Pen’s father Jean Le Pen in 2002) the result was a very convincing win for the opposing candidate Jacques Chirac as left wing supporters of the losing Socialist nominee Lionel Jospin threw their support behind the “anyone but Le Pen” platform.
Current polling suggests a similar, though less decisive, outcome if Le Pen runs-off against either of the two most likely alternative contenders, the centre-right Francois Fillon or the independent Emmanuel Macron.
Given the failure of polls to accurately predict Brexit or the victory of Donald Trump there is understandably some scepticism about the certainty attached to that forecast outcome.
Moreover, Le Pen and the National Front has clearly achieved a higher level of support than in years past – she has made a concerted effort to remove some of the more extreme elements of her father’s party (including him) and has succeeded to date in broadening its appeal. It nevertheless remains a radically Nationalist political force and would, in the event of achieving power, represent a dramatic change at the very heart of European politics.
Of principal interest for financial markets is the party’s very firm anti-EU and anti-Euro stance – Le Pen has called the EU “objectively a total failure”. If Le Pen was to assume the presidency and seek to remove France from the Euro then it is difficult to see how either the currency or the body could survive. A Le Pen victory would be a much more significant event than Brexit.
In Germany a federal election is scheduled for the 24th September.
The Christian Democratic Union (CDU), led by long standing German Chancellor Angela Merkel, remains favourite to stay the largest party in the German parliament (the Bundestag) and to form the basis of government. But the rise of the right wing Alternative for Deutschland (AfD) party has raised concerns that it may be able to form a king-maker role. The AfD was only formed in 2012 and initially had a platform of moderate Euro-scepticism but has since focused its policies on being anti-immigration (particularly from Islamic countries) and more sceptical of the EU and has seen its support rise from below 5% to around 15%. This has happened at a time when support for the CDU has fallen from above 40% to nearer 30%, and its coalition partner, the centrist Social Democratic Party has also fallen from 25% to around 20%.
The Bundestag is elected in a proportional representation manner, very similar to New Zealand’s MMP, so a status quo government will depend upon the CDU and SPD in combination garnering a majority of the vote – an outcome at this stage that looks more likely than not, but it is by no means certain. The potential outcome in Germany looks less extreme than the risk in France as even if Merkel is unable to form a government the continued membership in the EU is not likely to be questioned. However, the loss of a figure of such stability and authority would undoubtedly give rise to uncertainty over the near-term direction of the Union.
And finally, and much closer to home, the day before the German federal election, New Zealand goes to the polls.
The resignation of John Key late last year has dramatically altered the state of NZ politics, significantly increasing the probability of the next government being formed by a Labour/Green coalition.
Undoubtedly a change of government will have some effect on the local market but many of the issues that appear to be driving a populist resurgence in Europe are thankfully absent from the local political debate and it seems reasonable to hope at this stage that whatever the outcome of the election, we will be able to enjoy the continuation of a relatively stable and rational government.
There will of course be a myriad of other macro factors that have an impact on markets and, more importantly, within it all there will be companies endeavouring to drive earnings higher and, where successful in doing so, are likely to see their valuations increase.
We can’t ignore the macro so we keep a weather eye on important global events, but ultimately it is our view that the performance of your investments will be most affected by us understanding and investing in the best stock opportunities that we can find.
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