Can election fever prove harmful to investors?

This was always going to be a busy year for elections in the Bric economies and emerging markets in general.

Some have gone largely as expected, for example Jacob Zuma’s return to power in South Africa surprised no one. Others delivered wins for anti-corruption candidates, with Narendra Modi’s landslide win shaking up the political scene in India, while Joko Widodo emerged victorious in a closely fought Indonesian poll. In Turkey, prime minister Recep Tayyip Erdoğan won the country’s first direct presidential election, while Dilma Rousseff faces a real battle if she is to retain the Brazilian presidency.

But what effect do these polls tend to have on markets and how closely should investors be following them? 

 Markets tend to overestimate the importance of elections, believes Jan Dehn, head of research at Ashmore, explaining that although they are genuine piece of uncertainty, once they are over this dramatically declines. “This is why the run up to elections are often periods of temporary weakness – buying opportunities – while the period immediately after elections often produce rallies.”

Markets also tend to exaggerate differences between candidates, he adds. “In most developing countries there are very strong political and institutional constraints on the behaviour of political leaders, which means that the extreme scenarios painted by analysts prior to the election itself often turn out to be massive exaggerations.”

Mr Dehn highlights the election of presidential candidates Ollanta Humala in Peru in 2011 and Luiz Inácio Lula da Silva’s win in Brazil in 2002. Both of which were viewed with “massively overdone pessimism” but both proved to be good leaders of their countries.

 Nevertheless, governments have the right to tax, imprison, nationalise, go to war, and in some cases even kill their own citizens, says Mr Dehn, and so elections should always be a concern for investors. “But in the vast majority of countries in emerging markets elections are smooth processes that have become institutionalised since the end of the Cold War in 1989. In most cases, they are peaceful events that provide a bit of excitement rather than existential risks for the market.”

Not such a smooth ride

Emerging markets tend to be more volatile than developed countries in general and this is often due to politics, warns Heinz Ruettimann, emerging market strategist at Bank Julius Baer. “For instance in Thailand we tend to see political turmoil more or less every 18 months, which obviously has a market impact. And what will happen when the king – who is 87 years old – dies? His death will certainly lead to a political crisis and a power struggle.”

He views elections as market-moving events and believes you have to take them into account when it comes to asset allocation. And a good way of doing that is looking to the past. “Have their been political landslides? Is it a multi-party country or does it just consist of a few big political parties? How many parties are needed to build a coalition? To what extent does the ruling party have to share its power? What is the shape of the economy, which often has to be in a bad shape if there is to be a landslide?”

Unless it is a big country such as China, which makes up 18 per cent of the MSCI Emerging Market Index, elections tend to have a local impact, says Mr Ruettimann. To have a global impact the country must be large and well integrated into the global economy, and also to be a global consumer. This is not really the case in Brazil or India, he explains, but local markets can move significantly.

“When we had the so-called elections in China in November the market moved after the elections; in Indonesia the market moved before the election; in India the sentiment has been so positive that the market moved both before and after. In Brazil the market has moved before the election because there is a lot of hope for change.”

He believes that political elections in emerging markets have become of much greater importance. “After 10 years of boom, these economies are now in need of reform, and the starting point for that is normally an election.”

Emerging markets are currently going through a period of significant change which makes the current spate of elections important, agrees Phil Langham, head of emerging markets equities and senior portfolio manager at RBC Global Asset Management

Many of these markets have been through a period of relatively poor performance, with profit growth, margins and return on capital in the last three or four years quite weak, he explains. “If you have had a period of relatively poor economic performance, elections can spur a change in economic management.”

These countries have to make a decision about their economic model, says Gary Greenberg, head of emerging markets at fund management firm Hermes. “Are populations willing to move in a liberal or supply side direction which may mean taking on a little bit of pain but would mean becoming an economy whose growth model is sustainable? Some countries, such as Mexico, made that decision earlier, Taiwan and Korea are already locked into that, and China in 2013 made a decision to go in that direction.”

In India it certainly appears as if the electorate has come down firmly on the side of change. Narenda Modi ran on a platform of implementing much-needed reforms and with a promise of ending the corruption that has blighted the country for years. He was rewarded with India’s first single party majority since 1984, and the strength of the mandate he was given surprised even the bulls, says Rahul Chadha, co-chief investment officer, Mirae Asset, pointing out that Indians approached this election in a very different way to previous ballots.

“In the past, people had always voted along religious lines. This was the first time since independence that individuals voted as if it was a presidential election.”

This was partially down to a generational shift, he explains. “Young people’s aspirations have changed. In the past it was all about handouts. They want jobs now.”

But just because an election takes place and a market-friendly government is voted in does not necessarily mean they are going to be able to carry out the types of things they have promised, warns Mr Greenberg at Hermes.

“Modi won a huge mandate which ought to mean he has an easy time making the changes but actually he has an Augean stable to clear out, and whether Modi actually does have enough power is questionable,” he explains. “Not everybody in his party is as clean as he is and there are a lot of vested interests. The system has evolved to the point where corruption has become embedded.”

Mr Greenberg is hopeful that India will be able to get back to the 7-9 per cent growth rate it once enjoyed, which would bring a whole lot of people out of poverty and allow India to move to a modernising economy model, but warns that taking on these vested interests will prove difficult, though not impossible.

Indonesia has also elected a reform-minded candidate, although president-elect Joko Widodo also faces an uphill struggle if he is to implement radical change. Early signs are encouraging, with talks underway over abolishing the fuel subsidy which has ballooned to around 20 per cent of the government’s budget. However investment opportunities are limited, says Mr Greenberg.

The market has to some extent anticipated a good result from this presidency and yet it  remains fairly sceptical that Indonesia will become a centre for exporting goods, he says. “Nobody questions the domestic consumer story, but can Indonesia reform its labour laws and improve its infrastructure and become a destination for FDI? Indonesia is always going to be able to grow at 3 or 4 per cent. But can it transform itself into a global player in some way? The jury is very much out on that.”

Too close to call

Brazil goes to the polls on October 5 and is one election that is very hard to predict. Incumbent Dilma Rousseff of the Workers’ Party is running for re-election, having been hand-picked by the previous, and extremely popular president ‘Lula’ Da Silva as his successor. A comparison of the markets and opinion polls would suggest that they are angling for a change – whenever her ratings drop the stockmarket seems to gain a few points, while currencies and bonds are also affected.

This is because the president has not been running the country at all well, explains Didier Rabattu, head of global equities and manager of Lombard Odier’s Emerging Consumer Fund. “She has been trying to do everything on her own, spending a lot of money on things like the World Cup, using big companies such as [state ownwed energy firm] Petrobras as a source of finance. She is not putting Brazil on the right path.”

Lombard Odier would change its allocations to Brazil depending on the outcome of the election. At the end of 2012 Mr Rabattu explains how the bank felt Brazil was entering a downward spiral, and reduced its exposure to the country. It built it back up to around 8 per cent late last year in anticipation of the World Cup and upcoming election coming, “but we would reduce it very quickly if we felt she was going to win the election”.

However it is unlikely that significant change will be coming to Brazil no matter who wins the election. “We seem to be heading for a situation where the country is going to be relatively evenly split and therefore it is unlikely that we will get a strong mandate,” says RBC’s Phil Langham. “Brazil does require some very strong decisions to be taken, but the sweeping reforms that we are seeing in China, India and Indonesia are unlikely.”

There is probably much more at stake than the market thinks, adds Ashmore’s Mr Dehn. A narrow win for Ms Rousseff, which  he thinks is likely, will almost certainly force her to turn to the centre and to replace her economic team. This will be bullish. The same would happen if the opposition wins. “The big question in Brazil is whether any politician would undertake deeper institutional reforms,” he says. “This seems unlikely regardless who wins.”

But there could be one big winner if she loses, predicts Mr Greenberg at Hermes. “Rosseff’s opponents are hardly likely to be tremendous reformers, but compared to her they will be. The primary beneficiary if she loses will clearly be Petrobras who should see much less government intervention.”