Euphoric markets are ignoring growing political risks

THE PAST year has brought war to the Middle East, escalation of the trade conflict between the West and China and, on July 13th, an attempt to kill the frontrunner in America’s presidential race. But if you look at financial markets, you’d think nothing was amiss. No amount of blood or political rancour, it seems, can distract Wall Street from the good economic news: that fears of recessions have so far proved wrong, and that inflation has nonetheless tumbled. As a result markets are at, or close to, all-time highs in America, the euro zone and Japan, and many emerging-economy stocks are booming, too. Optimism is rife. Compared with companies’ profits, America’s stocks have only ever been this pricey during two previous booms.

It may be that the attempt on Donald Trump’s life was a random act without profound implications. America has a long history of attacks on politicians; neither the two attempts on Gerald Ford’s life in 1975 nor the one on Ronald Reagan’s in 1981 brought on crises. Yet the fact that it is easy to imagine partisan loathing inspiring an assassination attempt is a reminder of America’s political dysfunction, which is spilling over into global disorder. And if Mr Trump and his young running-mate, J.D. Vance, ride on a wave of solidarity to the White House, there will be another round of disruption. As his speech at the Republican convention showed, Mr Vance amplifies, more eloquently, Mr Trump’s isolationist instincts. Europe could face at once the loss of its NATO security umbrella and the economic pain of more American protectionism.

Why are investors unperturbed by these threats? One reason is that the real economy has so far adapted to global tumult remarkably well. As the trade war has raged, Western companies have redirected their supply chains through “alt-Asia” countries including Vietnam and India (often veiling links to China, rather than severing them). When it had to wean itself suddenly off Russian gas, the German economy adjusted rather than collapsing. The damage wrought by tariffs has been obscured by America’s long-running jobs boom and the stimulus provided by its enormous deficits. Innovation, most notably the advent of generative artificial intelligence, has proceeded apace.

Yet it would be naive to think that the global economy is impervious to politics. Its prosperity ultimately depends upon the liberal, democratic and peaceful foundation on which modern capitalism has been built. It is telling that the good news investors are celebrating—the relatively painless reduction in inflation—has been achieved by central bankers, who are relatively insulated from political meddling. But politicians could set aside the taboo on interfering with interest rates, just as they have lately got over past misgivings about subsidies and tariffs. Mr Trump excoriated Jerome Powell, the chairman of the Federal Reserve, during his first term. If Trumpism lives on after 2028 through Mr Vance, who laments the strong dollar, then it is hard to see how the Fed will keep its independence in the long term.

The countries that are sitting out today’s stockmarket boom offer cautionary tales about the consequences of adverse politics and disruptions to trade. The worst-performing big market over the past year is China’s, which is down about 10% in dollar terms. Despite increasing admiration in the West for Chinese state capitalism and crowing in Beijing about turbulence in America, China’s recent economic growth has been disappointing. Its authoritarian government, lacking the discipline and dynamism demanded by democratic politics, has failed to resolve its property crisis or to fight the slowdown by stimulating consumption. In the West, Britain’s stockmarket has underperformed terribly since the country voted to leave the European Union in 2016, a decision which has disrupted trade flows with its closest partners. This week shares in TSMC and other tech firms fell after Mr Trump suggested that Taiwan should pay America for its defence guarantees.

In parts of the world—albeit not places that investors care much about—the real economy is suffering from the decline of the old order. Since the covid-19 pandemic developing countries have no longer, on average, grown faster than rich ones, as they did during the heyday of globalisation after 1990. Many of the poorest countries are encumbered by large debts that are difficult to escape because creditors, including China, are reluctant to respect the special status of the imf, which they view as an arm of Western power.

Eventually political and geopolitical ructions will hurt the rich world, too. Nothing encapsulates Wall Street’s complacency about this possibility better than a growing belief that Mr Trump’s return to the White House would be good news for investors.

In recent days, as the perceived odds of interest-rate cuts and a Trump victory have grown, they have piled into small-cap stocks. It is true that cutting the corporate-tax rate from 21% to 15%, an idea Mr Trump has floated, could mechanically boost profits, that deregulation helps and that bigger deficits are stimulative. But the economy is running hotter and America’s budget is far more stretched than at the start of Mr Trump’s first term in office, both of which mean higher inflation is likelier than faster growth. Mr Trump has long viewed the stockmarket as a gauge of his performance and so may ditch his barmiest ideas. But it is not a good sign that being bullish about Trumponomics means hoping that its most harmful parts will be ditched under duress.

Bulls and a China shock

And if Messrs Trump and Vance were to allow more wars in Europe, or move towards the total decoupling from China that some national conservatives advocate, economic chaos would ensue. Investors would be hammered. Such a descent of the world order into turmoil would be worrying for investors were stocks priced normally. With their valuations sky-high, it is a recipe for a crash. Political risk is difficult for markets to price. But that does not mean they should ignore it. ■

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