Nonsystemic and Systemic Effects of Political Decisions on Stock Investments - dummies

Nonsystemic and Systemic Effects of Political Decisions on Stock Investments

By Paul Mladjenovic

Government regulations can change the playing field in businesses. Therefore, the outcomes of politics can affect your stock investments in two basic ways: nonsystemic and systemic.

  • Nonsystemic means that the system isn’t affected but a particular participant is affected.

  • Systemic means that all the players in the system are affected. Laws typically affect more than just one company or group of companies; rather, they affect an entire industry, sector, or the entire economy — more “players” in the economic system.

In this case, the largest system is the economy at large: To a lesser extent, an entire industry or sector can be the system that’s affected. Politics imposes itself (through taxes, laws, regulations, and so on) and can have an undue influence on all (or most) of the members of that system.

Nonsystemic effects

Say that you decide to buy stock in a company called Golf Carts Unlimited, Inc. (GCU). You believe that the market for golf carts has great potential and that GCU stands to grow substantially. How can politics affect GCU?

What if politicians view GCU as a monopolistic entity and want the federal government to step in to shrink GCU’s reach and influence for the sake of competition and for the ultimate benefit of consumers? Maybe the government believes that GCU engages in unfair or predatory business practices and that it’s in violation of antitrust (or antimonopoly) laws.

If the government acts against GCU, the action is a nonsystemic issue: The action is directed toward the participant (in this case, GCU) and not the golf cart industry in general. (See the nearby sidebar for more about monopolies.)

What happens if you’re an investor in GCU? Does your stock investment suffer as a result of government action directed against the company? Let’s just say that the stock price will “hook left” and could end up “in the sand trap.”

Systemic effects

Say that politicians want to target the golf industry for intervention because they maintain that golf should be free or close to free for all to participate in and that a law must be passed to make it accessible to all. So to remedy the situation, a law is enacted that all golf courses must charge only one dollar for any golfer who chooses to participate.

That law sounds great to any golfer. But what are the unintended effects when such a law becomes reality? Many people may agree with the sentiment of the law, but what about the actual cause-and-effect aspects of it? Obviously, all things being equal, golf courses will be forced to close. Staying in business is uneconomical if their costs are higher than their income.

What happens to investors of Golf Carts Unlimited, Inc.? If the world of golf shrinks, demand for golf carts shrinks as well. The value of GCU’s stock will certainly be stuck in a sand trap.

Examples of politics creating systemic problems are endless, but you get the point. Companies are ultimately part of a system, and those that control or maintain the rules overseeing that system can have far-reaching effects. All investors are advised to be vigilant about systemic effects on their stocks.