By ten o’clock on Thursday night, when the exit poll was revealed, the European Union question had replaced the general election question in the minds of investors.
While Nigel Farage and UKIP saw little return for their 12.6% vote in terms of seats in parliament, the reality is they got what they wanted a long time ago when David Cameron committed to holding a referendum on Britain’s EU membership if he won.
The way this issue is handled and the final outcome is now going to be a dominant investment theme in the UK and to some degree across Europe until it is resolved one way or the other.
The resounding nature of Cameron’s win is likely to embolden him in his negotiations with EU officials and counterparts in the other major European countries. The aim will be to restore power to the UK parliament over border controls and sweep aside much of the red tape and interference in the British legal system, while retaining free trade with the rest of Europe.
If such a deal is reached it is highly likely Britain would vote to stay in, stability would be ensured and asset prices would rise.
Should Cameron be given nothing new of substance to put to the public however, a vote to leave the union would be a significant possibility. That is the kind of political earthquake that can rock markets across the region and even globally for a significant period.
This increased uncertainty could have serious implications for risk assets, according to consultancy Fathom Consulting. “This initial market euphoria is unlikely to last as markets wake up to the realities of a Brexit referendum. We estimate that the risk premium on sterling assets could rise by as much as 200 basis points in anticipation of a Brexit referendum, pushing sterling down by more than 10%. The FTSE All-Share could lose as much as 30%.”
“The rise of the nationalist vote, including UKIP, is consistent with the political landscape in Europe and raises all sorts of questions which will be endlessly debated,” said Rowan Dartington Signature’s Guy Stephens. “Perhaps this will embolden Cameron when the fun starts with the EU referendum but it was noteworthy that this issue and the union were the main things he mentioned on his acceptance speech in Witney,” he added. “His unilateral stance in Brussels is perhaps quite aligned with the UK electorate who want reform more than anything else.”
In one important respect there was more certainty delivered rather than a new question. The Conservative majority means Cameron, Osborne and co will be able to pursue the tighter fiscal policy they believe in. This will buy significant breathing room for Mark Carney and the Bank of England as the UK’s borrowing costs will now not be forced higher by market expectations of tax and spend from a Labour/SNP government.
The Bank will therefore be able to stick to its carefully measured approach of staying ‘lower for longer’ with rates rising gradually based on favourable economic data, rather than a loss of market confidence in UK fiscal policy.
“It also now abundantly clear interest rates will rise for the right reason – namely because the recovery is continuing to gain strength,” said GLG UK Income Fund manager Henry Dixon. “There had been a real concern that international investors would have been spooked by a left of centre government, causing sterling to fall and therefore forcing the Monetary Policy Committee into action with a series of ‘bad’ rate rises needed to stave off inflation.”
Long before we get close to the referendum though, there will be some clear winners from the result in terms of sectors and asset classes.
Wellian Investment Solutions’ Chris Mayo pinpointed property as something to watch now. “The markets have also shown that share prices of various estate agents have risen this morning which is a clear and positive indicator for the mid-term performance of property funds with exposure to London and the South East,” he said. “As these funds invest in tangible bricks and mortar they sit comfortably in any multi asset portfolio and have the ability to generate a stable income stream. The newly appointed Tory Government will serve to act as a catalyst to ensure these funds see significant growth in the months ahead, making them a highly attractive option for today’s investor.”
At the front of the line of equities sectors set to make gains in the near term are the banks, with the threat of heavy-handed intervention from a Labour government removed.
“The real winners are the banks, which we as investors can now look at in a much more favourable light,” Dixon said. “You can’t underestimate the confidence banks will be feeling now in terms of their futures and this could be an inflexion point for them, potentially drawing a line under PPI claims, bringing an end to the fine culture, and creating a more constructive outlook generally.”
Energy companies are also likely to be lifted by the possibility of state price fixing being removed while house builders could benefit from improved sentiment.
A pretty rosy picture for investors all round, but good times will be short-lived unless the EU question is answered well.
