General election: silver linings to the cloud of uncertainty


Richard Buxton, head of UK equities, Old Mutual Global Investors, argues that while the result of the election may not have been the obvious preference of the financial markets, there remain reasons to be optimistic and assesses the sectors most likely to benefit.

Most of us had become familiar with Theresa May’s distinctive prime ministerial style in the nearly 10 months she’d been living behind that famous black door. ‘Brexit means Brexit,’ we had been told with monotonous regularity. But the strategy seemed to be working, and her personal popularity, as well as that of her party, soared to ever loftier heights.

To her, the decision on 18 April to call a snap general election, despite repeated previous declarations that she would not do so, must have been as obvious as it was irksome to her political opponents.

But as the campaigning got underway, it seems probable that the prime minister must have begun to doubt the wisdom of her choice to call the election. Last night, any remaining doubts must surely have been swept away, and she will be rueing her decision. As dawn broke over a hung parliament, voices began to call for her resignation. Whether she will survive as party leader, and for how long, is at this stage anyone’s guess.

We will now face a period of horse trading and a possible Conservative leadership contest, as parties attempt to form a functioning government. But the headline results of the vote may be masking the real forces that drove the outcome. As initial polling analysis is starting to show, the young voted overwhelmingly for Labour, while older generations voted for Mrs May’s Conservatives.

In other words, this was a vote by the young against soaring student indebtedness and a dysfunctional housing market. The young were Remainers, and the old were Brexiteers. This was the moment when the young finally found their voice. For those who have never experienced 1970s-style inflation and unfunded giveaways, the message of Jeremy Corbyn’s Labour Party proved irresistible.

This begs the question though: where did it all go so badly wrong for Theresa May? The now infamous Andrew Neil interview on the so-called ‘dementia tax’ may well go down as the moment when Theresa May's position as Prime Minister started to look shaky. If there is an irony here, it is that there is now every probability that we will see the emergence of more policies that will have the effect of transferring wealth from the older to the younger generation, just as this policy would.

Whoever becomes prime minister will be negotiating with Brussels from a distinctly weakened position. In real terms, this means that there is a much greater likelihood that the UK will find itself having to settle greater dues to the European Union. If this cloud has a silver lining, it is that the EU may, in such circumstances, take a more benevolent stance.

Just as was the case in the EU membership referendum, the most marked and immediate expression of the result of the vote in the financial markets was seen in the movement of sterling relative to other major currencies; the pound fell initially by approximately 2 per cent against the US dollar, before paring those losses somewhat.

These declines in the value of sterling were less extreme than some forecasters had predicted, quite possibly reflecting the market’s perception that an extreme form of Brexit is increasingly unlikely. Moves in gilt yields (reflecting the UK government’s cost of borrowing) and in equity index futures (financial instruments that enable investors to express a view on the likely future direction of a market) were similarly modest.

Whatever shape of government the horse trading leads to, it seems clear that austerity-type policies are likely to be voted down. Investor hopes for reductions in the rate of corporation tax will surely be dashed.

While the long-term outlook for the UK economy will be dictated to a large degree by the negotiations with Brussels, in the near term it is the fortunes of sterling that are most likely to influence the stock market. Currency movements will inevitably have a significant bearing on the relative performance of the FTSE 100 and FTSE 250 indices.

Weakening UK economic data – as indicated by rising inflation and 10-year gilt yields at approximately 1 per cent, versus 10-year US Treasuries at 2.2 per cent – have acted as headwinds to the more domestically oriented small- and mid-cap markets. As such, although there remain pockets of expensively priced small- and mid-cap stocks, when viewed as a whole, the small- and mid-cap markets have been trading at cheaper valuations than their larger peers.

While it is easy for those with an interest in politics to become distracted by the excitement of an election, it is important to remember that the events unfolding on British television screens and social media feeds are taking place against a backdrop of accelerating global trade. The big natural resources businesses that dominate the UK’s large-cap index will be the key beneficiaries of this trend.

At a sector level, we remain relatively optimistic on the prospects for the listed housebuilders. The most significant potential impediment to the sector’s continued progress had appeared to be a discontinuation of the Help-to-Buy scheme, of which there was no mention in the Conservative manifesto. As we enter an era of increasing anti-austerity, the scheme’s survival prospects may now improve.

Conversely, the environment for energy suppliers and other utilities seems almost certain to become increasingly unattractive, given the political capital those on both sides of the divide believed they could make out of the topic of domestic energy costs.

For bank stocks, it is likely to be a question of hope being, once again, deferred until market interest rates begin a gentle ascent towards something approaching more normalised, pre-financial crisis levels. To some degree, this will depend on whether the US central bank, the Federal Reserve, follows through with its earlier policy and hikes interest rates, and the extent to which President Trump continues to be frustrated in his efforts to make reforms.

Patience will be required though, as despite rising inflation, it seems likely that softening economic data will be taken by the Bank of England’s Monetary Policy Committee as an opportunity to leave interest rates on hold, once again delaying expected improvements in the profitability of the UK’s commercial banks.

Against a backdrop of declining bond yields, and a general increase in risk aversion in the run-up to the election, it comes as little surprise that the UK stock market leader board has been dominated by ‘defensive’ businesses like British American Tobacco and the publisher, Reed Elsevier.

With this election now mercifully behind us, and the threat of a cliff-edge ‘no-deal’ Brexit waning, there may just be some cause for optimism that risk appetite will make a return. Although a period of uncertainty will not be welcomed by the market, any further signs of a ‘softer’ Brexit, combined with the tailwind of still-improving global demand, could bode surprisingly well for UK companies.


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