Politics doesn't affect the economy as much as we fear it does – here's why

How much do politics really matter for financial markets? That might seem an odd question, for a number of reasons.

We have just had an extraordinary three months for financial markets, with the Trump rally pushing US share prices up by nearly 20 per cent since the election. Next Tuesday the President addresses the two houses of Congress, when he is expected to give details of his tax plans, and which may or may not sustain the rally.

Politics in the UK have certainly affected the currency, with the pound down around 15 per cent since the Brexit vote. And politics in Europe have started to feed through into a weakening of French bonds vis-à-vis German ones, a reaction to the possibility of Marine Le Pen winning the presidency there. She has suggested redenominating the French national debt back into francs and promised a referendum on membership of the euro.

So of course politics matter. But on a very long view maybe they matter less than people think, and we are advised, are we not, to take a long view of investment strategy?

I have just been looking at investment returns over the past 117 years, thanks to an annual study of these published by Credit Suisse. This is one of the two long-term investment reports, the other produced by Barclays and out next month.

Let’s put current political into this long historical context. Take an extreme possibility. It is that following political upheavals in France and/or Italy, one or other of those countries votes to leave the Eurozone.

Now answer this: would the end of the euro be more important in global terms than the First World War and Second World War, the double-digit inflation of the 1970s and 1980s, or indeed the transformation of China to be on its way to becoming the world’s largest economy? The answer is surely not. Even if that were to lead to a transformation of the EU back into something like the original Common Market, that too would be far less important than a world war.

It follows that on a 100-year view the sort of political unrest that we had last year and what might come this year is pretty small stuff. So what impact did those much larger political earthquakes have on investment?

The first point is that if you take any long period, say 20 years or more, equities produce a better return than bonds or cash. Indeed they are the only asset class that almost always gives a higher return than inflation. If you take US assets in real terms (ie, allowing for inflation) equities have given an average annual return of 6.4 per cent between 1900 and 2017, bonds 2 per cent, and cash (the study uses treasury bills as a proxy for cash) 0.8 per cent.

The US unsurprisingly does rather better than most countries, but the UK does not fare too badly, with equity returns averaging 5.5 per cent. For people who grasp the maths, these averages are geometric means rather than arithmetic means. The arithmetic averages work out somewhat higher: 8.4 per cent for the US and 7.3 per cent for the UK.

But shares go down as well as up, and they are generally more volatile than bonds and, of course, cash. The worst year for equities in nearly half the markets studied was 2008. So the world has had recent experience of a really bad market crash. The worst for the US was 1931 and for the UK was 1974.

Actually, the period since 2000 has been a generally poor one for shares, in contrast to the 1980s and 1990s, which were very good. Still, we are at least up on 2000 in the UK, and if you add in dividends, well up.

These are averages for how markets have performed as a whole. What about sectors? Here the message is that the high-tech boom so evident in the US now is nothing new – or rather having one sector dominate a market is not new at all. Back in 1900 two-thirds of the value of the US stock market was accounted for by railway shares. It was half the market in the UK. By contrast technology, the largest US sector, now accounts for less than 20 per cent of the value of the market there, and hardly any of UK market. The commercial base for shares now is much broader than it was 117 years ago. You could argue that as a result shares should be more stable now than they were a century ago.

None of this says anything about what shares will do in the coming weeks or indeed years. What it does do is put investment into the context in which it should be put: the very long term. And if that is a comfort to people looking around a troubled world, well, it should be a comfort.