Traditionally, political risk has been about war, coups d'état, sudden and disruptive regulatory action, and expropriation of property. But suddenly now, political risk is reshaping markets and frightening investors.
Last week, we saw the Dow Jones slipping after South Korea announced penalties against North Korea for supposedly torpedoing a Southern patrol ship in late March and North Korea announcing threats to South Korea. North Korea's Dear Leader had obviously decided the S&P needed to be reined in.
At the same time, shares and the euro crashed after Germany's Angela Merkel announced Germany would ban naked short selling. The week before, investors had been hammered after French President Nicolas Sarkozy had threatened to pull France out of the Eurozone to force Germany to agree to the rescue plan for Greece. Tensions have been rising since Merkel's centre right coalition suffered a loss in the crucial state election in North Rhine-Westphalia.
Political risk is now shaping markets as never before, says Jeffrey Garten professor of international trade and finance at the Yale School of Management.
The problem, as the New Yorker's James Surowiecki points out, is that bringing politicians into the equation makes the global markets more volatile and even less predictable. "Political risk is hard to manage because so much comes down to the personal choices of policymakers, whether prime ministers or heads of central banks,'' Surowiecki writes. "And those choices aren't always going to be economically rational-witness Merkel's recent tergiversations … Investors, then, are being forced to read the minds of policymakers-not something they're good at. Markets work best when there's lots of information available and a historical track record to go on; they excel at predicting things like horse races, election outcomes, and box-office results. But they're bad at predicting things like who will be the next Supreme Court nominee, as that depends on the whim of the President. Also injecting uncertainty is the fact that, even when politicians do the right thing, timing is all."
Get ready for more volatility. Political risk has always been one of those concepts that wasn't supposed to apply to investment and markets. That's changed substantially.
no comment untill now