Important facts to know about politics and the stock market

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“Just because you do not take an interest in politics doesn’t mean politics won’t take interest in you.” – Pericles

Many investors believe that politics do not influence the stock market. They like to keep a distance from the liberal-conservative or the Democrat-Republican debate. While it is acceptable to not be a part of the daily debate, one must not ignore the fact that a fish can never survive in poisoned water.

So, how can the stock that you choose survive if the policymakers are against it?

The stock market is affected by a number of macro factors. “Macro” means the external and uncontrollable factors that include interest rates, inflation, economic outlook, and changes in policies, and also politics. 

Politics and the Stock Market

Let us see how politics affects your stock with an example.

An investor invests money in the stock of a company. This company is part of an industry which caters to a particular sector. Different sectors constitute an economy. An economy runs on a set of rules and policies which is designed and passed by politicians and policy-makers.

Suppose you put your money in a highly profitable company that manufactures insulin. The government decides that the drug is extremely vital for the people and should be affordable by all. As a result, in order to keep the insulin prices in check, it should fix the price of the drug.

They pass a law stating that all the companies manufacturing insulin should now sell it at a fixed rate. Though this law seems promising for the patients, it can have some serious repercussions:

  • If the price to manufacture is more than the price to sell, the companies will no longer be interested in manufacturing the drug as it will eventually drive them out of business.
  • Once the price of the drug is fixed, it will drive more consumption. One of the main reasons is because the drug is within an easy reach of people.

Result: Increased consumption of the drug coupled with lower profit margin will compel the companies to shut their manufacturing units. This will eventually lead to a shortage of the drug. Since the price is fixed and companies are ready to shut their units down, this means more number of people will be laid off. Eventually, people will lose jobs, manufacturing units will shut down and the insulin-making industry will vanish.

This is just one example of price control that can compel even the profit making companies to close. Price Controls are usually put in effect because the government wants to prevent:

  • Inflation: When giant private corporations deal in a particular sector, they have the power to drive the prices. The consumers are happy as long as they are competitors. But imagine what will happen if corporations come to a truce and decide to start selling the commodity at a higher price. With no other alternative, the consumers are forced to pay more. This will become truly gruesome if the giants belong to the pharmaceutical or oil companies.
  • Monopolization of the sector: When a company starts making huge money in a particular sector and eventually holds the position to influence the price of the commodity, the government can intervene and enact the law to fix the price. In worst cases, it can even the nationalize the company.

Policies and Regulations

There are other ways in which the policies and regulations can affect the company or the stock market. It is important for an investor to foresee the reforms in order to make a wise decision. Before investing your money, make sure to check all the criteria mentioned below:

  • Taxes:
    • Is the government going to introduce a new form of tax? If yes, which sectors are likely to be affected?
    • Subsidies will usually drive the consumption higher whereas selective taxation can reduce consumption because of increased prices.
  • Money Supply and Interest Rates:
    • Is the Central Bank i.e. Federal Reserve or Reserve Bank going to increase or decrease the money supply?
    • The Central banks can control the supply of money by modifying the reserve requirements. Reserve requirements refer to the amount of money the banks can hold. By lowering the requirements, the banks can loan more money and eventually more money will flow into the system and vice-versa.
    • Lower interest rates can increase the economic activity but can also drive the prices higher, leading to inflation. For example: In the 2008 economic crisis, the Central Banks of Europe kept the interest rates extremely low which negatively impacted their economies.
    • When the interest rates are high, most of the people will tend to save their money in banks. The circulation of money in the economy will lower leading to a drop in the stock prices. Also, it will be harder for companies to take loans and earn profits. Higher interest rates usually have an adverse affect on the stock prices.
  • Price Controls:
    • Is the government keen on passing a law that will control or fix the prices?
    • This can be detrimental to the commodity. It usually drives the price of the stock down.
  • Regulations:
    • Is the government going to regulate the imports and exports of a particular commodity? If yes, then what are the companies that are primarily manufacturing those commodities?
    • How will the regulation affect their stock price of the commodity?
    • If the imports are decreasing, this will create a shortage of the product and can eventually drive the price higher. However, if the imports are increased, the increased competition between the local and the foreign companies will drop the price of the product and the stocks of the manufacturing companies.

Other factors like war or natural disasters can also drastically set the economy in turmoil.

Key Takeaways

Whether you like politics or not, it is going to influence your stock. So, you certainly cannot avoid it. As a wise investor, you should foresee how government policies could trigger the movement of your stocks that you hold.

After all,

“Successful investing is about managing risk and not about avoiding it.”

Disclaimer: The information in this article is not intended to encourage any lifestyle changes without careful consideration and consultation with a qualified professional. This article is for reference purposes only, is generic in nature, is not intended as individual advice and is not financial or legal advice.

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