The price of politics
This week’s election will be watched by investors, but few expect it to have the same impact on markets as the EU referendum.
The 57th UK general election season has proved to be more interesting than expected. Since it was first called, there have been two significant changes.
The first is that the polls have shifted dramatically. When Theresa May called the election, polls tended to give her a 20-point lead, and a Commons majority of more than 100 seats. Labour was widely expected to suffer a historic defeat. Most polls now put the Conservative lead in single figures following a Labour surge. A Conservative majority in the Commons remains the median expectation, but a hung parliament has become a racing possibility – indeed, the latest YouGov poll indicates the Tories would fall 22 seats short of a majority.
The other change has been in the outlook for the UK economy. Growth figures in late 2016 put paid to the idea that a vote to leave the EU would precipitate an instant recession, as the UK economy’s growth rate surpassed all other G7 countries. Yet data for the first quarter of this year showed a marked slowdown, while inflation has reached a four-year high.
Individual investors try to price expected future events into markets as early as possible. When Theresa May called the election, sterling rose to a six-month high, partly on expectations that she would win a strong mandate, giving her a tailwind as she headed into EU exit negotiations. As sterling rose, so the FTSE 100 dipped – since the earnings of multinationals listed on the index lost value in sterling terms. As confidence increased, so the yield on the 10-year UK gilt began to rise.
All these movements have begun to unwind in recent weeks. Gilt yields now sit at a seven-month low, suggesting nerves on markets. Sterling’s upward trajectory against the dollar had fizzled out by early May. The FTSE 100 has risen around 6% since the day after the election was announced.
Nevertheless, these reversals have only been partial, which suggests that investors still expect a Conservative majority, but a smaller one than they did just a few weeks ago.
It is also important to remember that the EU referendum had only two possible outcomes – since markets made the wrong forecast, the reaction to the result was all the stronger. Yet the general election offers a range of possible outcomes to respond to, and commercial odds broadly reflect expectations, for example: Conservative majority government (2/9), Conservative minority government (12/1) and Labour minority government (20/1), according to data collated by Oddschecker.1
Yet it would be unwise to invest based on political outcomes. A period of volatility could certainly follow the announcement of the election result, perhaps especially if there is a hung parliament, since it would prolong political uncertainty. Sterling might suffer as a result. Initially, that should push up UK-listed stocks, although political uncertainty might well cap any gains. Indeed, it is possible that the greatest beneficiary would be UK government bonds, as investors take flight to safety.
It is important to remember that bouts of volatility are inevitable on markets, and should not be feared. The UK has a strong history of forming governments quickly, even in unexpected hung parliaments – as was the case in 2010. Election-induced volatility is unlikely to last long. Investors should keep their primary focus on the horizon – and on the companies themselves.