Why elections are good for your investments

“All Thais must remain calm and government officials must work as normal”, said General Prayuth in a televised broadcast to the Thai nation on 22 May 2014.

This was the beginning of the military coup of Thailand. The Royal Thai Armed Forces had just taken control of the country. The incumbent prime minister, Yinluck Shinawatra, was to be replaced due to abuse of power. The military, General Prayuth promised, would restore order and enact political reforms. Shortly thereafter, the streets of Bangkok were filled with troops.

Hardly sounds like a recipe for a strong stock market, right?

Well, yes, at least in Thailand it is. After a short dip, the Thai stock exchange started to climb and is now up almost 7% since then – making it one of the best performing stock markets in the region.

Sidestepping the finer points of Thai politics, I think this is a perfect example of the positive impact politics can have on the markets.

Most foreign investors miss out on these opportunities though. Political upheavals – particularly elections – are the sorts of things that can really spook them. It doesn’t help that they’re bombarded by a cacophony of political news from analysts who prefer the status quo and paint changes in a bad light.

Today, I want to tell you why these investors are missing out – and why we won’t.

It’s better to rock the boat

So how do elections affect  the markets?

Well, to answer that, I’ll turn to famed statistician Nassim Nicholas Taleb.

Taleb offers two major insights on the subject. The first is that “variation is information. When there is no variation, there is no information”.

Certainly, there’s a lot more information running around emerging markets these days. Current elections are the first time a generation raised with the internet are really participating. Everywhere in Asia, I find young people glued to their smartphones/tablets observing and sharing what they see or read. Even when I’m stuck in a traffic jam I notice young professionals picking up their gadgets from their laps when traffic comes to a standstill.

So with more information comes more variation. Remember that the electorates in emerging markets are a mere two generations away from the end of the colonial era (1940s/50s) or one generation away from the fall of Communism (late 1980s).  These people want change and they’re not afraid to make noise to get it.

Political noise is healthy for markets. It’s when you try to supress the noise that things go wrong. Let’s look at what Taleb has to say on the matter.

How China’s ‘election’ policy is hurting it

He writes that “complex systems that have artificially suppressed volatility tend to become extremely fragile, while at the same time exhibiting no visible risks. In fact, they tend to be too calm and exhibit minimal variability as silent risks accumulate beneath the surface.’

China is a prodigious example. When searching the International Foundation for Electoral Systems (IFES) database for information on China, I found only the message ‘No data available’.

But are we really that surprised?

I think Max Fisher of The Washington Post summed it up best. Following the ‘election’ of president Xi Jinping in early March 2013, Fisher made the following wry summary of the event:

2956 – Number of votes cast in China’s presidential election

2952 – Number of votes cast for Xi Jinping

1 – Number of votes cast against Xi (plus 3 abstentions)

0.0002156819 percent – Share of the Chinese population granted the franchise in this election

99.86 percent – Xi’s share of the vote…

But investors disliked the wall of silence when the Chinese economy started going through many structural challenges. The Shanghai Composite Index has dropped over 9% since then, making it one of the worst-performing emerging markets in the world this year (-5%).

Ergo noisy and loud emerging markets are worth listening to. And if you still need convincing, let’s have a look at the numbers.

Elections give stock markets a shot in the arm

So far this year, four leading emerging markets have had major elections.

These were Thailand in February, India in April and, South Africa and Egypt in May.

In the second half of this year we can look forward to three major emerging markets holding elections: Indonesia in July , Turkey in August and Brazil in October

With the exception of Brazil, all these markets have one thing in common: they outperformed the MSCI Emerging Market Index which only gained 6%).

So what should we make of this?

Well clearly, elections are good for the markets.

Elections are a momentum trade. Based on a study by Morgan Stanley of 27 emerging market elections since 2000, emerging markets tend to outperform 3.1% one month prior election, but after the election, the outperformance fades away.

James, my colleague covering Latin America, can comment about the Brazilian election in due course, but the election I’m most excited about is Indonesia’s presidential one.

In just two days’ time, Indonesians will go to the polls – and it could be a big deal for your investments.

A clash of titans

Right now in Indonesia, there is a close battle between the governor of Jakarta, Joko Widodo (aka Jokowi) and General Prabowo Subianto (Gerindra). Jokowi is the candidate for the current opposition party Partai Demokrasi Indonesia Perjuangan and if the election swings in his favour, the market will receive a boost.

I’ve made no secret about my high hopes for Indonesia. The country is set to join the $1trn club next year, has the second biggest democracy in emerging markets after India, and is endowed with a young population (26% of the population is under 15 years old).

What is interesting from a tactical point of view is that in spite of robust performances for Indonesia, this year foreign participation remains lacklustre  with less than 1% of net buying of market capitalisation – equivalent to about a third/half of the level coincided with previous peaks in foreign flow. The low participation rate hints that good election news will push them even higher.

And when it does, we’ll be waiting.