Market Bulletin - Interesting times
The election did not provide the result that pundits expected or that markets prefer – it may take time before politics in the UK settles.
‘May you live in interesting times’, goes the old curse. Its force is surely not lost on the prime minister just now.
London’s leafy Kensington is the UK’s richest constituency and not normally a bellwether of the national mood, but last week it summed up Theresa May’s woes. A Kensington constituency has existed since 1974, and has always been firmly in the Tory heartlands. On Thursday Labour won it by just 20 votes, one of the more extreme examples of a broader shift in political sentiment that has taken place in recent weeks. Indeed, perhaps the most striking statistic of the election was that Labour won 40% of the national vote, up from just 30% in 2015.
Kensington also announced a day late. Faced with an extended recount, its tellers were eventually sent home to sleep off their exhaustion before resuming their reckonings. Kensington’s fatigue was felt nationwide – two general elections, a Scottish independence referendum, and an EU membership referendum in the space of less than three years is a lot of politics. Yet much remained up in the air, even after the prime minister had announced that the Queen had asked her to form a minority government. The prime minister has already publicly expressed her confidence in the prospects for a deal between the Conservatives and Northern Ireland’s Democratic Unionist Party (DUP) – the DUP’s ten seats would turn a Conservative parliamentary minority into a narrow majority.
Theresa May had of course gone to the polls to secure an unassailable majority ahead of EU exit negotiations, which are due to start on Monday next week. Instead, despite winning 56 seats more than Labour, she now cuts a diminished figure, having seen a 20-point polling lead fall into single figures in a matter of weeks. There were several factors apparently at play, some of her own making. Symmetry was one: the Leave vote had been an anti-establishment move dominated by older voters. That establishment has since declared itself not just for Brexit, but for a hard Brexit; last week’s vote had a strong ‘Remain’ element and saw the highest turnout of young voters since 1997. Theresa May hadn’t banked on a revenge vote.
“May’s honeymoon was over the moment she opportunistically called for a general election,” said Stuart Mitchell of S. W. Mitchell Capital. “[Consider] her tortured logic that a greater Tory majority would improve Britain’s negotiating position with Brussels. The various weaknesses of her character became at once very apparent – the hint of authoritarianism, her inability to operate collegiately and above all her fragility when under pressure. Britons were also somewhat unsettled by the ‘no deal is better than a bad deal’ approach to the Brexit negotiations. How did this bring the country together after such a punishing referendum campaign?”
As it happened, the prime minister did succeed in a few lesser aims. UKIP limped out of the poll looking like a spent force, having haemorrhaged votes to both Labour and the Conservatives, while the Scottish National Party lost a third of its seats, capping hopes for a second independence referendum any time soon. Yet the outcome was largely a personal and political disaster, and Theresa May must now rely on DUP votes to get her way. Not everyone believes she can survive long, even if the poor economic growth rate of the first quarter proves to be a blip and not a trend. Data published by Visa last week showed that UK consumer spending has fallen on an annual basis for the first time in almost four years.
“In all the heat and light that accompanies an unexpected political outcome, a lot of extreme conclusions have been discussed by market and media commentators [but] economically not a lot has changed – in some respects, the outlook for the UK economy has improved,” said Neil Woodford of Woodford Investment Management. “My expectation now is that the new Tory-led administration will adopt a more stimulative position – borrowing more and spending more. Overall, this will be positive from the perspective of UK economic growth.”
News of a hung parliament immediately pushed the pound down by a couple of cents against the dollar, but thereafter it appeared to find its level. Meanwhile, a poll conducted by the Institute of Directors showed a “dramatic drop” in business confidence following the news of a hung parliament – business leaders had feared the election risked adversely impacting the economy at just the time the government should be focusing on EU exit negotiations.
“Sterling will be the key driver for markets, with the FTSE 100 supported due to the high exposure to overseas earnings,” said George Luckraft of AXA Investment Managers. “The ensuing uncertainty is a negative for the UK economy, with some decisions being put on hold. Theresa May’s position is seriously damaged, with sections of the Conservative Party likely to look for change. The case for further austerity appears to have been rejected, with a probability that the budget deficit will be higher whatever the government.”
The currency dip helped push up the FTSE 100 on Friday, although it ended the week down 0.27%. The yield on the 10-year gilt ended the week marginally tighter, but yields were already very subdued.
“We believe the excitement of the media about the surprise outcome will be short-lived and economic realities will come to dominate investor actions in the coming months,” said Sandro Näf of Capital Four Management. “As a result, we expect, just like during summer 2016, a muted market reaction to the recent political developments in the UK. We continue to believe that the UK economy is healthy and able to absorb the transition to a more independent economic area.”
Markets elsewhere were relatively unmoved. The Eurofirst 300 ended the week down by 0.5%. There were reasons for the phlegmatic response, among them the fact that the election had multiple possible outcomes and investors hadn’t simply banked on one of them – unlike in the EU exit referendum and US presidential election. Moreover, Theresa May’s position on the UK’s EU exit had hitherto been forthright – her failure to capture a parliamentary majority may now change that.
“If anything, perhaps the odds of a softer Brexit go up now – but the process will be even more convoluted,” said Blake Hutchins of Investec Asset Management.
Matters of state
If investors seemed relatively unfazed, it is also possible that they were simply baffled. Despite the alliance with the DUP, the election has increased political uncertainty in the UK, weakened the government, and lowered the chances of the prime minister enjoying a free hand in EU exit negotiations. She is now potentially faced with war on two fronts – at home and in Brussels. More positively, it may be that the UK engages in a much deeper domestic debate on the nature of its exit, since she will require more cross-party support than she had once countenanced.
Some Tory Remainer MPs have already said they will push for a softer EU exit. Even David Davis said that leaving the single market may no longer be feasible, while Nigel Farage warned that the exit timetable may be pushed back. Michel Barnier, leader of the EU negotiating team for the UK’s exit, also said a postponement might be needed.
Yet in her first public statement after the result was confirmed, Theresa May said that she planned to get on with the job with an unchanged timetable. In theory, that means she must be ready to begin next week, although little tangible progress is expected to be made before German federal elections in September. The 19,000-odd statutory instruments the UK has signed up to over the past few decades may have to wait a little while longer before finally being unwound.
Not all eyes were on the UK last week, however. In Continental Europe, an early Italian election looked increasingly plausible, the ECB took some first baby steps towards winding down its quantitative easing programme by saying it would not lower rates any further, and Emmanuel Macron’s party looked set for a landslide in France’s parliamentary elections. Meanwhile, minutes released by the US Federal Reserve last week pointed to a rate rise later this week, and markets have certainly priced one in.
Yet while central banks drew some attention, the city of Washington D.C. appeared to stop in its tracks for the day to watch the Senate testimony of James Comey, as he spoke about claims that President Trump had pushed him to drop an investigation into the latter’s links with Moscow. The S&P 500 ended the week up 0.12%. The odds for Donald Trump being impeached dropped after the hearing, but the mere fact it is being talked about is a reminder that politics is at a volatile moment – even if markets remain calm for the time being.
AXA Investment Managers, Capital Four Management, Investec Asset Management, S. W. Mitchell Capital and Woodford Investment Management are fund managers for St. James’s Place.
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