Richard Buxton (pictured), Head of UK Equities, Schroders, examines the impact of the UK general election on stockmarket sentiment.
If there is any consensus amongst investors, strategists and financial commentators, it is that in the run-up to polling day sterling will weaken further, gilt yields will rise and the equity market will fall.
The prospect of a hung parliament is a central scenario for many and, with it, the prospect of ineffective government and a crucial inability to take decisive action to rein in Britain’s fiscal deficit.
As this outcome looms ever closer, so investors will sell sterling, gilt yields will rise in anticipation of the UK losing its AAA-rated sovereign status – plus heavy gilt issuance as far as the eye can see – and equities will inevitably be dragged back by rising bond yields.
Clearly, as markets traditionally hate uncertainty, it would be no surprise if equities were indeed nervous and weak ahead of the election. But the election is hardly going to come as a shock item of new news. Is it likely that the arrival of the formal campaign triggers massive investment flows or haven’t all the possible outcomes already been factored into investors’ decision-making and market prices? With that in mind, maybe the real surprise will be that the market blithely ignores the daily twists and turns of opinion polls, speeches & debates, and maintains its current buoyant trend.
At least all three main political parties seem to be agreed on the need to cut the deficit – merely disagreeing on the methods and the timing. Whilst a Lib-Lab pact might be unappealing to many who work in financial services, it isn’t a foregone conclusion that their combined deficit reduction plan wouldn’t be well received by bond investors.
Equally, so great is the size of Britain’s national debt mountain that all parties agree that it cannot be tackled simply through increasing taxation and cutting spending. Economic growth has to be part of the solution as well. Hence, probable policies to encourage companies to remain domiciled in the UK, to invest and to take on additional workers. The next government is likely to be very business-friendly, since it is on companies’ ability to employ more people and deliver economic growth that the politicians’ re-election chances will rest.
Shrinking the size of government will mean additional opportunities for the private and voluntary sectors to fill the voids created through the retrenchment of the public sector. Historically, periods in which the public sector has diminished as a percentage of GDP have witnessed increased productivity growth – an area where Britain has indeed lagged in recent years as the public sector has grown. None of this sounds particularly troubling for UK equity investors or, indeed, sterling.
Meanwhile, as even the most bearish commentators are prepared to concede, the majority of the earnings of UK-quoted companies are derived from outside the UK. Global economic recovery and the effects of very rapid and effective cost-cutting have ensured that recent company results have almost universally exceeded analysts’ expectations. There have been substantial increases in profit forecasts for many companies in recent months.
In turn, this has meant that valuations have remained reasonable throughout the market’s year-to-date gains, as rising earnings forecasts have underpinned rising share prices. Balance sheets have been repaired, cash flows are strong and, in a growing number of cases, companies are sitting with excess cash – a source of future investment, share buybacks or M&A.
Yet investor sentiment has rarely been so cautious. Highly respected investors are sitting cashed up on the sidelines, shaking their heads in disbelief as the market grinds upwards. Investment flows are out of equities, not into them. So great is the size of Britain’s fiscal deficit that the universal expectation is for some years of austerity as the nation tightens its collective belt. Growth borrowed from the future by the explosion in private & public debt in the last ten years must be repaid through several lean years.
But equally, as tough fiscal policy measures are rolled out, the corollary is that monetary policy is going to remain very loose. When the Bank of England starts raising interest rates towards the end of this year, it will move very cautiously. Interest rates are unlikely to exceed 2% throughout the whole of 2011 – a rate that in all probability is going to be negative in real terms. As a result, it is costing you to hold cash, whilst there are many sound equity investments yielding 2%, 3%, 4% or more.
Meanwhile, for all the universal and uncontroversial expectation of some years of austerity, bear in mind that in nine months time, 2012 will be ‘next year’. 2012 will see not only swathes of overseas visitors drawn to the Olympics, but the Queen’s Diamond Jubilee – an event likely to incorporate extensive royal visits up and down the country. These events are rarely economically depressing, but the reverse – ‘better repaint the scout hut for the royal visit’, etc.
If ever the coincidence of two events is likely to create a huge ‘feel-good’ factor in the UK, 2012 is the year. Austerity? Boom, more likely.
My forecast for the election? The Conservatives win a workable majority and all talk of a hung parliament is forgotten. Moreover, unlike the consensus view, they actually prove quite capable in government. And the stockmarket quietly ignores the whole campaign.
