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How should investors react to the forthcoming general election?

27 November 2019

While opinion polls give the Conservatives a large lead, the UK electoral system and tactical voting make predicting the outcome particularly hazardous.

The Tories, under Boris Johnson, are firmly committed to the Brexit deal he negotiated with the European Union (EU). The Brexit party will not stand against sitting Conservatives, and seems less relevant as a result. The remain camp is rather more divided, with Labour favouring negotiating a new deal, and then holding a referendum with deal or remain as the options. While Jeremy Corbyn has said he would remain "neutral" in a second referendum, many leading party members have said they would campaign for remain. This includes Keir Starmer, the current Shadow Secretary of State for Exiting the EU, who if Labour won the election and he retained his post, would then potentially be campaigning against a deal he had negotiated.

The Liberal Democrats and Scottish Nationalists are more firmly committed to remaining a member of the EU. The problem is that on a constituency by constituency basis, the Brexit referendum did not follow party lines. Exact data is not available, but it has been estimated that, while 52% of the voters were for leaving the EU, 64% of seats (about 403) voted to leave[1]. On the surface, this favours the Conservatives. However, 148 of those seats were in Labour constituencies, and about 80 Conservative constituencies voted to remain. The Brexit issue is the key issue and it clearly challenges the tribal loyalties of party politics. Several prominent Conservatives may lose out to tactical voting despite being in previously safe Conservative seats. John Redwood, Dominic Raab and Ian Duncan-Smith all represent constituencies that voted remain in the referendum. It has even been suggested that Boris Johnson could lose his majority due to student votes, although 57% of his Uxbridge and South Ruislip constituents voted for leave. In the past, less than 100,000 voters in a small number of marginal seats could swing the election result. This time there may be many more seats changing hands and as a result, many more voters may be important.

Market reaction

The Brexit effect has been most keenly felt in the foreign exchange market. A deal and softer Brexit has seen the pound strengthen, conversely when "no deal" has looked more likely, the pound has weakened. For the UK equity market, where there are a high proportion of international companies, a stronger pound has generally been negative for equities. The uncertainty around Brexit has deterred international investors, which makes the UK look cheap. During the election campaign, almost all parties have suggested higher spending, although the Conservatives have been more moderate in comparison to the Labour party's radical plans to increase spending by £83 billion, as outlined in their manifesto. This has since been increased by an estimated £58 billion commitment to compensate women whose retirement age was extended. Increased taxes and spending on this scale are unlikely to be viewed favourably in the currency or bond markets. If we are to have a Labour-led government, then the fall in the pound could support some equities, but the share prices of companies, subject to their nationalisation plans, would be expected to fall.

Many investors would welcome a Conservative majority, but their manifesto makes a commitment on Brexit that may just cause more problems in the future. Boris's Brexit deal has an implementation period while a new trade deal is agreed, concluding at the end of 2020. The deal allows this to be extended by two years, but the manifesto says there will be no extension beyond December 2020. While Boris has promised a comprehensive trade deal, Sabine Weyand the EU Director General for Trade, said last week that the UK would only get a "bare bones" deal or no deal at all, by the end of next year. The Tory leader has managed to get a deal when most people thought he could not. However, trade deals take time (typically as long as seven years) and we could still be playing brinkmanship with the EU at the end of next year. While the pound may react positively, at first, to a Conservative victory, the reaction may be limited by further uncertainty on trade. The stocks that have been threatened by nationalisation should find support in these circumstances.

The bookies have the Conservatives as favourites for a majority. Expected outcomes have less impact than an against the odds outcome. A Labour outright victory is seen as a low probability, however it would have a much larger impact on investments.

Trade negotiations

Away from UK politics and domestic issues, the outlook for global equity markets is much more dependent on developments in US-China trade negotiations than UK politics. In the last two months, perceived progress on trade issues and moves by the European Central Bank and Federal Reserve to fend off recession risks have supported global equity markets with the FTSE All-Share Index rising despite the rally in the pound versus the dollar. However, the UK has lagged other developed markets in local currency terms. Currency moves aside, in the end, the election may have less effect on markets than people think. 

Beware of knee jerk reactions

The result comes out on Friday the 13th, no doubt it will be unlucky for some. A Conservative victory is largely expected, but may not be not be fully priced-in. Although any reaction will most likely be muted. The second most likely outcome would be another hung parliament. This could see many different possibilities, most of which would result in another Brexit referendum and consequently more uncertainty. We caution against making any drastic investment decisions on the expectation of any particular outcome. We continue to believe that a diversified, balanced approach to investing is the most appropriate course of action.



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