This year’s UK general election is shaping up to be the single most important event risk for investors, warns Aidan Donnelly.
The degree of political and policy uncertainties surrounding the UK’s general election in May is unusually high, and some of the potential outcomes could have significant implications for the economy and the stock market.
The outcome on election-day will only be the first step towards lifting uncertainties, as polls suggest that it is almost certain that coalition talks will have to be opened between two or more parties in the aftermath. Even if negotiations are successful, any future policy programme will be determined by the balance of power that exists between the parties, and this will ultimately colour the fiscal choices that will be made.
Long-term stability of any government cannot be guaranteed and voters could be asked to vote again sooner than currently assumed if coalition talks fail and snap elections are called, or if the new government decides to call a referendum on EU membership.
In terms of fiscal policy stance, there is little to choose between the three leading parties, with the Conservatives pledging the fastest reduction in the deficit and Labour promising to do it ‘as soon as is possible’, which likely means over the life of the next parliament. The Liberal Democrats lie somewhere in between. Given the fact that some elements of government expenditure will be viewed as sacrosanct, deficit reduction will likely come from greater cuts in the non-protected government departments, which could have significant impacts on certain industries that rely on this spending.
FEELING CONFIDENT, PUNK?
Although many things in political life are uncertain, past experience has been surprisingly consistent in one important respect: in every UK general election since the early 1980s, consumer confidence rose during the two years prior to an election and then declined substantially during the two years afterwards.
This even happened in 2010, and over the past two years we have also witnessed a rise in confidence – though, that may now be on the turn.
The uncertainty associated with the election result itself, together with the medium-term prospect that fiscal policy may be tightened significantly, makes it plausible that this ‘electoral cycle’ in the consumer confidence index could repeat itself once more. While the impact of a repetition of this pattern on the market overall is difficult to gauge, what is more certain is its impact at a sector level. In the past, changes in consumer confidence have been associated with market leadership changes, and there is little reason to believe that the same things won’t happen again. If history is a guide, we would likely see a shift away from domestic oriented stocks towards more internationally exposed ones.
This shift to more global names would also be driven by another factor. The prospect of tight fiscal policy and continued low interest rates suggests sterling will remain weak, particularly relative to the US dollar. As we have seen for many of the large export oriented companies in Europe, a weak currency can be a great boon to your business as it, on the one hand, improves your competitive position, and on the other hand, increases the profits from overseas operations when translated back into your own currency.
WINNERS AND LOSERS
With the overriding goal of all parties in the election being that of deficit reduction the major issue will be how this is achieved and therefore who is likely to bear the brunt of any changes.
Most of the potential initiatives relate to either the need for the government to increase tax revenues or the redistribute income from profit making sectors to households, making up for years of income stagnation. The upshot could be that certain sectors/industries face a combination of higher taxes and lower final prices which would impact profitability and share price performance.
The rationale for such policies is usually built on the need to regulate sectors with a degree of monopolistic pricing or excessive risk taking. It can, however, also result from politicians being politicians and looking for the populist outcome, in which case they could lead to lower long-term growth. Here again, details of those measures (scope, magnitude, timing) will be crucial to assess their overall and sector-specific impact.
Banks are also at risk in the form of tighter regulation and heavier taxation if a less ‘friendly’ government emerges from the May elections
INDUSTRIES IN THE CROSS-HAIRS
Given their domestic dependence, the utility sector is likely to be vulnerable. Electricity, gas and water bills are prime candidates for populist policies aimed at alleviating some of the strain on household finances resulting from continued fiscal consolidation. As well as the operational pressures that would result from the squeeze on margins under a more aggressive regulatory regime, any change to the long-term stability of the UK regulatory framework could drive negative sentiment toward the sector as a whole.
Banks are also at risk in the form of tighter regulation and heavier taxation if a less ‘friendly’ government emerges from the May elections. These would weigh on the earnings and would naturally have a larger impact on those banks with limited overseas or global investment banking operations. The other question for bank investors would be the future prospects for the UK government’s stake in Lloyds Banking Group and Royal Bank of Scotland.
A number of high-profile infrastructure projects such as the proposed runway at Heathrow have already come onto the political agenda and, as such, are vulnerable to the populist agenda. To the extent that these projects are delayed or scrapped entirely, companies geared into their development would be impacted.
A final industry that will be keenly watching the results of this election are the bookmakers – and not because punters will be having a flutter on the outcome. Under the current government we have seen many negative developments in the regulation and operation of the industry. Should the Conservatives remain in power, the sector would likely breathe a sigh of relief as many believe the recent changes are adequate. Under a Labour government this would not be the case and more stringent rules would likely follow.
While the outcome of the election and the shape of the next government remain uncertain, what is clear is that there will be stock market winners and losers in the aftermath. Being on the right side when the dust settles will be crucial to performance. How crucial? Only time will tell.
About the author
Aidan Donnelly is a senior equity analyst at Davy Private Clients.
Views expressed in this article reflect the personal views of the author and not necessarily those of Davy or anksusiness & Finance. Follow him on Twitter @aidandonnelly1.