Jeremy Paxman, being interviewed on a recent edition of Newsnight, stated: “Only an imbecile would call the next election.”
He said this with good reason as the permutations of the outcome of the election based on current polling are incredibly diverse. The next Government is more likely to be decided by politicians in the corridors of Westminster, as a coalition or minority government is negotiated in the days after 7 May, rather than a clear and definitive outcome being given by the electorate in the ballot box.
Let me explain why, whatever the outcome of 7 May, equity markets are underestimating the risk that the political uncertainty will provide.
My belief is that the most likely outcome of the election would be a Conservative minority government.
Minority government is not a remote concept – the likes of Canada, New Zealand, and Scotland, which all have political systems derived from the Westminster model have experienced minority government.
In fact, the United Kingdom technically had a minority government in 1996 through to 1997 when John Major saw his majority wiped out by by-election defeats and defections. He was only able to pass legislation with the support of other parties.
Minority governments can be perceived as potentially weak and unstable with a short-term approach to policy. This was certainly the case in Canada which has seen a variety of unstable minority governments which have led to political and constitutional crises.
However, both in New Zealand and Scotland minority governments have been more effective. They have the advantage that a single party ultimately has control of government and potentially the ability to pass legislation without having to tie them fully to a coalition agreement with one party.
But what does this mean for investors?
I have ranked the possible outcomes in the order of likelihood – in my opinion – of them occurring.
Conservative minority
A Conservative minority government would potentially be very unstable. The likelihood of a second election within months would be high, as it is clear that the Conservatives would try to gain a full majority in a second election when the electorate would be more predisposed to giving a clear view of direction.
This would spook equity, currency and bond markets. Business investment would slow, and this impacts UK economic growth which has a significant component of forecasts driven by 9-10% annual UK business investment growth.
Labour coalition or minority
A Labour coalition or minority government involving the SNP and/or the Liberal Democrats would have the same effect as a Labour majority government.
Sectors such as banking, utilities and gambling have already been identified by the Labour Party for increased legislation and tax-raising, and would be hurt further. Senior executives in other sectors such as telecoms have informed me that they are genuinely concerned that they may be targeted for further tax raising under a Labour government.
Both currency markets and bond markets would react poorly as the concern would be that Labour governments have traditionally spent and allowed deficits to rise. Furthermore, if it was a minority government then the instability that provides would provide further uncertainty, particularly with regard to inward investment into the UK.
Conservative-Liberal Democrat coalition
A Conservative/Liberal Democrat coalition is increasingly unlikely and the stability of the recent coalition is unlikely to be repeated if the scenario of Vince Cable becoming party leader was to occur.
Investors would have some comfort that there would be some continuity from the current coalition, but if Cable was leader then there would be significant concern amongst business leaders as the Liberal Democrats would have been dragged further to the left.
Conservative majority
An outright Conservative majority would provide the most comfort for investors – we would see continued rhetoric around deficit reduction, a continued commitment to corporation tax of 20% and a pro-business agenda.
This outcome would therefore provide more stability to sterling and also a flatter yield curve, as increased international investor confidence in the Government’s fiscal rectitude results in more buying of UK government bonds.
The only certainty is uncertainty
Paxman is correct to identify that the outcome of this election remains very uncertain, and whether I am right or wrong on a Conservative minority government is probably irrelevant.
The fact is that markets hate uncertainty and that uncertainty is not currently priced into equity, bond or currency markets. One only has to look at the Scottish independence vote to see how late in the day financial markets reacted to the possible outcome of Scottish independence. The polls had been indicating this for a significant amount of time prior to when markets actually became worried.
With uncertainty, comes volatility, and therefore opportunity. But there is absolutely no doubt that, for the first time in a generation, the outcome of this election really does matter.
