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The return of political risk

Certainly, it's a reminder that we can't measure risk merely by looking at historic volatility. By this measure, utilities are among the safest stocks on the market. But historic volatility tells us nothing about the likelihood of serious price controls, windfall taxes or nationalisation.

Nor should we take much comfort from the possibility that policies to shift income from profits to real wages could increase aggregate demand and economic activity because the propensity to spend from wages is higher than that to spend from profits. This is a probability rather than a certainty, and equity investors might reasonably fear - especially in the first instance - that lower profit margins won't be recouped through higher demand.

There is, however, one fact which cautions us not to worry very much about political risk - the recent history of the French market. France is widely regarded in the Anglophone world as a nation with anti-business, anti-market attitudes. And yet its stock market has thrived. Figures from MSCI show that since 1969 (when its data begins) French equities have actually outperformed the world market, rising by 6.4 per cent per year in local currency terms compared with 5.7 per cent for the world market. Granted, France has underperformed the freer market US in this time - but only thanks to the latter's better performance in the last two years.

This tells us that shares don't need a pro-market or pro-business culture to thrive. There might be good reasons for this.

One is simply that any systematic risk which doesn't materialise would raise equity prices. In late 1974, for example, investors seriously feared that capitalism might not survive. In retrospect, this proved to be the best-ever time to buy.

And there's a good reason why political risk might not materialise to a great extent. Employment depends, to a large degree, upon business confidence - companies' willingness to invest. For this reason, policies which would seriously hurt confidence and thus job creation are unlikely to be enacted. As the great Polish economist Michal Kalecki pointed out 70 years ago, this fact "gives to the capitalists a powerful indirect control over government policies".

What's more, some regulation is actually good for equities. A lot of 'red tape' is a fixed cost of doing business, which hurts smaller companies more than bigger ones. It therefore protects the latter from competition. Policies which slow down the pace of creative destruction can be good for incumbent companies and quoted shares.

And herein lies a paradox. A vibrant market economy would be a dangerous place for equity investors simply because tough competition would mean that profits are low and temporary. There's a big difference between a pro-market environment and a pro-business one. In this sense, while the prospect of new regulation might be mildly worrying for equity investors, it's not as alarming as the threat of a genuinely healthy free market. So we should be grateful that this is, in some ways, a distant prospect.