The UK General Election

poco.Author.AuthorName Chris Godding
13 December 2019
Ballot Paper Election

A solid result for the Conservatives and a market-friendly outcome. We are increasing our allocation to UK equities based on valuation, fiscal impulse and a partial reduction in the risk premium that has kept international investors at bay. Brexit is the remaining obstacle and the trade negotiations that will, undoubtedly go down to the wire.

The election result matched the expectations in the polls and secures the Conservative party a strong majority. 

Expectations versus reality

The result was in line with expectations but who thought they might actually be right!

  Voting intentions Seats
Conservative 43% 339
Labour 34% 231
Liberal Democrats 12% 15
Brexit Party 3% 0
Green 3% 1
SNP 3% 41
Plaid Cymru 0% 4
Other 2% 1
Northern Ireland   18

YouGov Poll 10th December 2019

Away from the opinion polls, the bookmakers were also indicating the likelihood of a Conservative majority, with the odds implying a 60% probability, although spreads were coming in quite quickly as we approached the election. Sterling was also well bid at 1.3180, reflecting reasonable market confidence in a friendly outcome. 

Initial market reaction

The currency is the best immediate indicator of the market reaction to the likely result and the initial move reflected a significant sigh of relief. Returning to levels last seen in mid-2018, it appears that investors have accepted Brexit and decided that the end of indecision is a broad positive that will soften the investment paralysis. In equities the response is more muted in GBP terms for the exporters, due to the currency appreciation but the reaction in domestic stocks is encouraging with a 2.8% rise in the MSCI UK futures. The election news also comes at a time when President Trump appears to have agreed to delay the imposition of further tariffs on China and buoyed global equities in general.

The immediate impact on the pound in currency markets was a 2.7% rally against the US dollar to 1.35 and a 2% rise against the euro to 1.20.

UK Pound Sterling Relative to US Dollar from 30/09/19

Source: Bloomberg

This is a strong positive reaction to the result and potentially an indicator that foreign investment capital will recover in the months ahead.

What happens now?

Parliament is scheduled to return for the election of the Speaker on Tuesday 17 December. MPs and members of the House of Lords swear an oath of allegiance before the Government sets the date for the Queen’s Speech and the State Opening of Parliament.

Boris Johnson will no doubt want to ratify the withdrawal agreement quickly and then begin trade talks with the EU and other major trading partners.

Our view

The most critical conclusion is that this comfortable majority for the Conservatives is positive for UK exposed investments as Prime Minister Johnson will not be dependent on the 20 or so hard Brexit extremists to pass any free trade deal through parliament.

The immediate economic downside for the UK leaving the EU with a deal on January 31 is estimated by Oxford Economics to be a relatively rapid contraction in GDP of 1.5% or £30bn peak to trough. However, there are other vital factors that could change the outcome significantly. The slowdown in global trade, combined with election and Brexit uncertainty has already led to a 1% fall in the growth of GDP in the UK this year. 

We are a trading nation and the combination of an improvement in the external environment, driven by the monetary stimulus, increased certainty and, perhaps even a trade deal may well offset much of the negative effect of leaving the EU, particularly in the coming transition year. External improvement aside, there will be a modest fiscal impulse that will aid domestic growth. Oxford Economics estimates that the net effect of the new Government’s spending plans, ex-global trade, and the impact of leaving the EU with a deal would be neutral to positive for the economy over a four-year timeframe. The actual outcome will of course depend on what the estimated £20bn in extra funding will be spent on. Public investment is hard to ramp-up rapidly, it is usually done badly and the manifesto only specifically details £3bn for 2020-21.

Conclusion

Our philosophy and process favours diversifying geographically as well as by asset class, and the drivers of long-term performance are more likely to be the larger macroeconomic themes and global market dynamics. That said, the UK is one of the most unloved and cheap equity markets in the world. It has significantly underperformed the broader MSCI World AC Index and we are increasing our exposure to UK equities post this result. Our approach to asset allocation is based on monetary policy, fiscal impulse and valuation and the UK scores highly across the board. The catalyst to reverse the negativity is certainty and, while the outcome may not be ideal for some, this result delivers certainty.

MSCI UK and MSCI World Price to Earnings ratios

Source: Bloomberg