Consensus has tipped a coalition government as by far the most likely election outcome, with many betting on the Conservatives to take top-spot.
Not-so-hot on their tail is the chasing pack, vying for the remaining governmental berth: Labour, the most likely challengers, followed by the Liberal Democrats, UKIP and Green Party.
Many investors believe that a Conservative-led coalition would provide the most market stability – but is the prospect of two other parties leading the economic rebalancing really that unpalatable?
“It is about whether a government looks strong enough to survive the course,” explained Iain Begg, professorial research fellow at London School of Economics. “The [Conservative-Liberal Democrat] coalition in 2010 – even before hindsight told us that it worked very well – looked strong enough to last for a while.
“Labour’s policy might do more good in the short-term but lead to long-term repercussions, and the Conservatives’ vice versa. However, that is where the respective party positions are at present, but once they are in power their agendas might cave in as they face the reality of governing. It only takes a whisper of threat from the market for them to ‘look at the books’ and postpone proposed policies.”
Market implications
Taking both the historical pattern of the incumbent party gaining popularity as election day nears and the current poll readings into account, it would appear that the market could be granted its wish of a Conservative-led coalition.
However, Justin Onuekwusi, lead manager of Legal & General Investment Management’s Multi Index range, believes that the market will feel the effects before the nation even goes to the polls.
“Going into the election there will be volatility in the gilt markets,” he said.
“With bonds, [investors] should diversify their holdings – do not just hold gilts, the risk has to be spread across different geographies via treasuries and other ‘safe’ bond funds.”
Another likely by-product of the election uncertainty is currency volatility.
“The clearest risk is to sterling,” said Onuekwusi.
“Given the likely weakness of sterling and almost 80% of UK company earnings coming in from overseas, there will be uncertainty in the equity market.”
But Richard Buxton, manager of Old Mutual Global Investors’ UK Alpha Fund, does not see a depreciating pound as necessarily a bad thing.
“The currency is already beginning to feel the strain,” he said. “Obviously it is partly due to the resurgent dollar, but sterling is clearly selling off against the euro and yen, among others.
“However, it is not a bad thing for a lot of quoted shares, so what is bad for the currency may not be bad for the stock market.”
Brown Shipley CIO, Kevin Doran, predicts a Labour-Scottish National Party coalition as the most likely outcome, which he sees as initially economically beneficial but having the potential to create problems further down the line.
“In the event of a Labour/SNP coalition, we would see more government bond borrowing, and therefore implications for the government bond market,” he explained.
“We would also see more money put into public services, which would provide a short-term boost for GDP. The immediate aftermath would be strong for the economy, but there are long-term implications.
Doran continued: “The market has been pretty forgiving in waiting for the UK to push through genuine austerity measures. We have not come close to sorting out the budget deficit. Granted it was 10% of GDP five years ago and now it is 5%, but 5% of GDP on a consistent basis will keep pushing the budget to GDP ratio up, and a default will quickly become inevitable. From that will come asset price inflation, then real world inflation, and finally inflation of UK debt.
“UK interest rates are likely to rise in October or November this year. In the short-term, because of the interest rate differential [between the UK and EU], sterling should be stronger than the euro. But because the sterling is a fundamentally-weak currency and with the large current account deficit needing financing, in the long-term the euro should strengthen versus sterling.
“International investors are very important when it comes to funding the budget deficit and even more so in funding the current account deficit, so we must be really careful not to alienate them. If we make the UK a less attractive place for investing that will be the catalyst for a sharp reduction in sterling against the euro.”
Brexit
Fanning the flames of election apprehension is the prospect a 2017 referendum on the UK’s place in the EU, as promised by David Cameron.
Buxton believes the UK exiting the EU would not be beneficial, but, on the other hand, does not see it as particularly likely given that there will be a two-year gap between the election and the referendum.
“The uncertainty of the Brexit question is not helpful, but the two-year window [outlined by Cameron] is sensible,” he said. “Cameron has clearly said to Angela Merkel ‘you can see what UKIP is doing so I have to pledge this’.
“The last thing Germany wants is the UK to leave the EU – we are a massive net financial contributor. During the two-year window he can negotiate some meaningful changes to Britain’s relationship with the EU, and the British electorate will probably recognise those changes and vote to stay in.
“Of course the two-year period will not be great for foreign direct investment, which, at the margin, is not helpful for economic activity.”
“The sooner we go to the polls, the more likely it is that the UK will leave the EU,” Doran said. “In the ultra-long-term that could be positive, but when the next financial crisis comes around – which will probably be in the next five years – what is to stop the EU imposing tariffs on goods imported from the UK? The UK would then need to diversify and sell to other nations, and the quickest way to achieve that is devaluing the currency.”
In the short-term, it seems that the biggest risk is to sterling – though savvy equity investors can benefit from this – while the government bond space could become even more unappealing than it already is.
In the long-term, a number of different risks lurk depending on who gets into power. but with politicking rife and party manifestos yet to be announced, there is almost nothing that investors can be sure of except uncertainty.
