Matthew Jennings, investment director for UK equities, Fidelity International, outlines the potential impact of the various possible scenarios after Thursday’s election.
When the UK’s prime minister Theresa May unexpectedly called a general election for 8 June in mid-April, her Conservative Party’s lead was large. Commentators agreed that her intention was to secure her position within an often divided party.
But a month is a (very) long time in politics. After several policy gaffes and with the Labour Party’s campaigning striking a chord with younger voters, May’s lead is dwindling and some polls are indicating May could even lose her majority altogether.
So what would the different scenarios mean for investors?
From the point of view of the market, a sizeable Conservative majority would be the preferred outcome from this election, and it is also very much the anticipated one. In this event we would be unlikely to see a significant equity market movement, all other things being equal.
While many investors might have been hoping for a landslide, most polls do show a narrowing between the two main parties with Theresa May remaining prime minister. The continuity offered by even a small majority for the Conservatives would probably still come as some relief.
For investors, a Conservative government would allow for a recovery or stabilisation in sterling exchange rates. This could, in turn, end the boost experienced by companies listed in London with revenues from outside the UK.
However, that might not last: investors’ attention will turn to negotiations with the EU, which are likely to be extremely challenging whoever is in power and whatever the size of their majority, and could well be a source of further volatility in both currency and equity markets.
A hung parliament would see the market trying to get to grips with two competing narratives.
Firstly, the old truism ‘the market hates uncertainty’ is likely to trigger currency and market volatility as investors ponder the scale of compromise to be made between parties of whatever hue as they try to form a government.
Secondly, assuming that the Scottish National Party or the Liberal Democrat Party plays a significant role in any coalition, a second Brexit referendum would suddenly become a real possibility for the first time, making investors re-assess their assumptions about Britain and the EU.
Overall, despite some inevitable volatility, the market is likely to wait and see what government emerges from the hung parliament before deciding how to react.
This would be a remarkable surprise and the market is initially likely to focus on what investors might think is the worst-case scenario under a Labour government led by Jeremy Corbyn.
Many of his party’s manifesto pledges are specifically designed to reduce the profitability of the UK corporate sector and to capture a greater share of GDP in taxation to fund public spending. The market would also have to grapple with the prospect of nationalisation occurring in certain sectors.
We should expect significant volatility in currency and equity markets as domestic and overseas investors adjust their exposures to reflect lower levels of expected corporate profitability in the UK under a Labour government.
However, this pessimistic (from an investor point-of-view) scenario assumes that Labour’s manifesto pledges are successfully legislated. It seems extremely unlikely that such a transformative programme could be enacted (at the same time as challenging Brexit negotiations), as Corbyn has much less support among Labour parliamentarians than the party’s electoral base.
It is quite possible that the market’s initial over-reaction to a Labour victory would create opportunities for companies which produce things that people will want to buy whichever party is in government.
The long view
However unusual and uncertain the current political landscape may seem, investors should try to avoid basing long-term asset allocation decisions on party manifestos, speeches, polls and commentary.
Every minute an investor spends on politics is a minute they could have spent better understanding company and industry fundamentals and valuations. Over longer time frames, these have a far more significant impact on investor returns than politics.
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