This year, you need to protect your portfolio from politicians

If there’s one thing we can expect in 2010, it’s that politicians across the world will have far more impact than normal on the markets and economy in general.

Much of the time, investors and businesses can get by without worrying too much about what politicians are up to. When things are going smoothly, our leaders have a reason not to rock the boat too much. So other than having to weather the occasional ill-considered tax change, investors (in the developed world at least) can usually relegate politics to background noise.

But investors will have to pay more attention to politics this year. For one thing, governments across the world – regardless of political philosophy – have rarely been more heavily entrenched in their economies. So what they do and say matters.

On top of that, when so many countries are in such fragile financial condition, the focus starts to fall on the leadership. That’s when signs of flakiness or weakness at the top can really cause problems.

So it’s rather bad news that the world’s politicians simply refuse to behave themselves…

Politicians are making waves in the currency markets

Politicians have caused ructions across the currency markets this week. On Wednesday, two ex-Cabinet members, Patricia Hewitt and Geoff Hoon, apparently rose up to throw off the yoke of Gordon Brown.

The plot – which failed, as usual – has bemused most observers. The Labour party has surely missed any opportunity to get rid of Gordon Brown. With less than five months to go to the election (16 weeks in fact, if you believe Jack Straw), the chances of being able to decapitate the party and stick a new, more attractive head on it without being utterly wiped out seem slim.

But whatever the reasoning behind the plot, it’s not the kind of thing to encourage confidence. Sterling took a dent as investors increasingly wonder if Britain can actually make it as far as the election without facing some sort of currency crisis.

Meanwhile, the new Japanese finance minister, Naoto Kan, caused the yen to slide as he “abruptly reversed his predecessor’s currency strategy” by calling for a weaker yen earlier this week, as the FT reports (see my colleague David Stevenson’s article Why the yen’s new high won’t last for more on this). That would be good news for Japanese exporters of course. The yen then rebounded this morning as Prime Minister Yukio Hatoyama said that “rapid fluctuations” in the currency were unwelcome, adding that “the government, at least as far as I am concerned, basically has no need to comment on currencies.”


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Iceland could set a bad example for other indebted countries

But probably the biggest political intervention we saw this week came from Iceland. President Olafur Grimsson refused to sign off on a bill committing his country folk to a schedule for repaying a £3.4bn debt to the British and Dutch governments. This is to pay for some of the cash paid out by these governments to people who would otherwise have lost savings with Icelandic banks.

The bill will now be put to a referendum in February. And the people of Iceland are unlikely to vote for the bill. That’s not necessarily to say that they won’t repay the debt, by the way – it’s the terms they’re objecting to.

It’s hard to blame Iceland on this one. As Jim Leaviss of M&G put it on the bondvigilantes blog: “the payment amounts to around £10,000 per person – a massive burden. I can’t imagine that UK voters would agree to make such a payment to a foreign government should the table be turned, and the Icelandic economy is in a worse state than ours.”

But, he continues, the real worry is that other troubled countries, particularly in the eurozone, will take Iceland’s decision as an example. One writer in the Irish Independent for example, suggested that “Iceland proves there is an alternative” to harsh austerity measures and pay cuts. If that’s what the Irish – who are doing a pretty decent job of taking the pain necessary to bring their economy back to some level of competitiveness – are thinking, then what of the Greeks? As Leaviss puts it: “2010 could be a year of angry populations and wobbly governments.”

What does this all mean for investors?

What does all this mean? Well, between now and the election certainly, sterling is vulnerable to every little hiccup and political spat. That’ll make for a very volatile ride. So we wouldn’t be making any big bets on the pound for now. Meanwhile, the euro potentially looks very fragile too. We’re happy to stick with Japanese stocks (mainly because they’re cheap), but the direction of the yen will clearly be much harder to call if the government is keen to talk it down along with every other currency.

As for the dollar, we suspect there’ll be a dollar rally this year as investors start to worry about the state of the global economy again. But if any recovery starts to look under threat, you can expect the Federal Reserve to step back in with various forms of money printing.

This is one reason why we think you should still be holding on to gold. As my colleague Dominic Frisby said earlier this week, it may be a tough year for the yellow metal. But it’s the only currency that can’t be controlled by governments, and therefore, it’s the one that’s most likely to hold its value against all the rest. That makes it a good insurance policy.

As for what else to buy – large multinational stocks look like the best bet. These companies aren’t heavily exposed to the vagaries of a single government regime, or a single currency. Again, that tends to lead back to defensive stocks, such as large consumer products providers or pharma companies which generate sales worldwide.

Our recommended article for today

One sector to watch in 2010

While many sectors of the UK economy struggle, technology continues to advance apace. Tom Bulford looks at some opportunities foro 2010 in the tech sector.


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