FTSE Shades of grey

As we enter the home straight for the long-awaited May 2015 UK General Election, we can look forward to a barrage of rumours, manifestos, policy promises and TV debates. While this is all very entertaining, as an investor I often wonder what effect political elections really have on stock markets. In most cases, I don’t think elections matter very much at all. After all, the stock market is a discounting machine. Market prices are supposed to reflect investors’ expectations of underlying fundamentals. Political elections are only likely to alter existing market expectations if the result is a surprise. And looking back at the last four UK General Elections, the results have tended to come in more or less as expected. But perhaps this time is different.

The key difference with this year’s General Election is uncertainty. We do not know who is going to win, and the rise in support for minor parties means almost any number of coalitions is possible. One online bookmaker is suggesting there’s a 70-80 per cent chance that no party will gain an overall majority. But whatever happens, the final outcome will not have been widely expected beforehand.

The last time the UK faced an uncertain General Election was 1992 when the Labour party were mildly ahead in the polls but the Conservatives, under John Major, managed to just scrape through. It was an unexpected result, and the stock market response reflected this. A generally pro-business and pro-market outcome, the stock market rallied 15% in the two months following, with the domestic and consumer focussed sectors such as financials, housebuilding and retail outperforming1, 2.

1992

Certainly, no election campaign is run in isolation, and the volatility that we are seeing return to markets, potentially exacerbated by the uncertainty swirling around Westminster, may present opportunities for the active investor. But what would another coalition mean for the market as a whole? Would colour, or shade, really matter to the FTSE? Here are some possibilities.

A Conservative majority would surely be the most business and stock-market friendly outcome. Under this scenario the sectors and companies that have been most hurt by the political and regulatory rhetoric of the past year could perform particularly strongly.

The bookmakers Ladbrokes and William Hill have, for example, spent much of the last 18 months under a cloud of uncertainty, as the Labour party has suggested that it may restrict the use of highly profitable betting machines. In a similar vein, the energy companies, in particular Centrica, have been hit hard by the frequent interventions of Ed Miliband who has claimed – unfairly, in my view – that these companies are profiteering at the expense of the consumer.

On the other hand, a Conservative majority or a Ukip coalition would make an “in-out” EU referendum almost certain. This would introduce a high level of uncertainty about inward investment plans into the UK and trading risks for all companies that do business in Europe. These could linger for some time, given the mooted 2017 date for such a referendum.

It is less clear what would happen under a Labour led government. A clear Labour majority would probably be poorly received by the markets, and may be seen as the most anti-business outcome, but to what degree is unclear as their hands would be tied by a need to demonstrate fiscal responsibility. We would probably have to wait until later in the year for the dust to settle to assess their policy actions. “Shoot first, ask questions later” is often how the stock market behaves in these situations – meaning any company or sector potentially in the firing line is not likely to perform well.

Aside from the areas already under attack, I would be concerned about new targets. Any sector that is high-profile and consumer facing could be at risk – like tobacco, the water companies, mobile or fixed line telecommunications firms.

Importantly – though ironically – a result which leaves a coalition or minority government might actually produce the best medium-term result for the stock market. While there would undoubtedly be volatility in the early days as politicians negotiate for their particular policy initiatives, this could settle down over time.

When it comes down to it, a weak government would not be able to diverge very far from the current status quo in practice. There would be no referendum on Europe and probably few transformational tax or policy changes.  The tight financial position of the country limits a weak government’s room for manoeuvre, and radical policy changes are unlikely to be passed through parliament. Furthermore, it is unlikely that any party would want to call a second general election.

Whichever of the two leading parties “loses” the election, they are likely to change their leader, and the Liberal Democrats may also be in the same position. Whatever the result, it’ll be an interesting night. I know I, along with many other market participants, will be staying up.

Simon Gergel

 

1. This is no recommendation to buy or sell any particular security
2. Source: Liberum Capital

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Author - Simon Gergel

Simon Gergel

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