The ripple effect: How politics and interest rates affect the stock markets
From tight election races to changing interest rates, the world can be pretty unpredictable — and uncertainty causes volatility in the stock market. Learn how from finance professional Kevin D. Flynn.
5 min read
Uncertainty causes volatility — one reason we see significant market movement during contested elections. Investors know that world leaders can set policies, adopt regulations, and influence congressional or parliamentary decisions. Conservatives think differently than liberals or labor parties on these issues, so elections can significantly change the game.A good example is Donald Trump's recent presidential election in the United States. He's a conservative advocate for fossil fuel economies and a self-branded "crypto candidate." Gulf Keystone (LON: GKP) jumped 6.73% five days after his election. Bitcoin(BTC) topped $90,000 almost overnight. Was this a stock market reaction to election results?
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Fund managers are always looking for new ways to project market movement. In 1967, acclaimed researcher Yale Hirsch developed thePresidential Election Cycle Theory (PECT) to predict the presidential election’s impact on stock market movement. This theory could be applied to any country with elected leaders on a term limit.According to the PECT model, presidents focus on their preferred policies and fulfilling campaign promises in their first two years. As the next election looms, they shift to boosting the economy so they or their party remain in power. The data behind the theory suggests that thehighest stock returns typically come in year #3, with year #4 a close second.PECT is a sound theory, but it doesn’t account for several other variables that affect market movement. While the president or other world leaders can catalyze change, they don’t operate in a vacuum. Other factors that must be accounted for are interest rates, inflation, global conflicts, natural disasters, and technological developments.
How do interest rates affect the stock market?
The European Central Bank (ECB) is responsible for setting a key interest rate that commercial banks use when they borrow from or lend money to other banks. The United States Federal Reserve Bank calls the overnight interbank lending rate a federal funds rate. Raising either of these rates is intended to reduce spending and mitigate inflation, which can affect the stock market.A quarter-point raise or reduction of the ECB's key interest rate or the U.S. federal funds rate does not significantly impact present-day share values, but it can set trends in motion that could have long-term effects. The ECB cut rates by a quarter point in October 2024, buttech and healthcare stocks on the STOXX 600 are still down.Retailinvestors and traders move quickly when economic conditions change. Institutional investors managing significant funds react more deliberately, and their actions have a greater impact on the stock market. That causes a lag between an FED or ECB interest rate decision and a major market movement. Election year stock market history shows a similar pattern.
When will interest rates go up again?
Candidates in this year’s elections were asked, “When will interest rates go down?” Serious investors want to know when they’ll go back up again. They’re not looking at the stock market after election day as a time to buy or sell their holdings. Rebalancing a portfolio requires more data, including the next projectedinterest rate cut or deduction.
The impact of global conflict on investors
The war in Ukraine and conflict in the Middle East have impacted stock markets in the European Union and the United States. Opposition to those conflicts has influenced political messaging during recent election campaigns. Uncertainty over the length and breadth of these situations is causing volatility in fossil fuels, agricultural stocks, and government bonds.The effect of conflict on the stock market can be seen in the performance numbers. Ukraine has been described as the “bread basket” of Eastern Europe. The Teucrium Wheat Fund (WEAT) is down 13.11% over the past twelve months. In the Middle East, the Saudi Arabian Oil Company (TADAWUL) is down 16.34% YTD. These are both direct results of global conflict.Of course, there’s another side to this. Newton’s Third Law states that for every action, there is an equal and opposite reaction. Ukrainian wheat and Saudi oil are down. Defense stocks are up. Take a look at Lockheed Martin Corp (LMT). Their gain this year is 17.28%, roughly the same as the losses we’re seeing in other sectors.
Natural disasters and green investment portfolios
We can’t discuss political events without talking about global warming. Weather conditions have deteriorated worldwide, the ice caps are melting, and the Paris Agreement is pushing for zero-carbon solutions. Special interest groups representing Big Oil and the automotive industry are opposing this. Climate change has been on everyone’s platform this election season.Green investment portfolios focusing on renewable energy and carbon-neutral businesses should thrive in this political climate, but that’s not the case. President Trump vowed to repeal the Inflation Reduction Act of 2022 in the United States, which provides clean energy subsidies.Solar energy programs in the EU are thriving, but solar stocks aren’t rising.Cost and insufficient infrastructure are hampering green energy initiatives. World leaders can make a difference by pushing for more subsidies and negotiating trade deals to decrease the cost of materials. Voters should keep this in mind when they go to the polls. Elected officials should be held accountable for the health of the planet.
How to react to market swings
Uncertainty causes volatility in the stock market. Historical returns from election years, periods of global conflict, and when interest rates are raised or reduced by central banks prove this. Investors can prepare for this by rebalancing or diversifying their portfolios. Understanding why the market is in turmoil can help you make better investment decisions.This article is not meant to be investment advice of any kind. It’s simply an introduction to some events and actions that influence stock market activity. Political events are one of those. Interest rates are another. Research these further, and speak with an investment professional if you need help rebalancing your portfolio.
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