November 2019: your client asks...what does the upcoming UK election mean for portfolios?
This monthly series looks at the economic and market issues making headlines, and provides straightforward answers to investors' questions. This month: what does the election mean for my portfolio?
How will the pound, UK shares and other investments fare according to election outcomes?
The upcoming UK General Election will inevitably have a significant impact on the course of Brexit. If the Conservatives win a majority, they should be able to push their withdrawal agreement through Parliament without too much opposition. Other results raise the possibility of a wider range of outcomes, potentially including a second referendum followed by another General Election.
A Conservative majority…
The latest polls suggest the Conservatives are on track for a majority. However, there is a degree of scepticism around polling heading into this election given a large number of undecided voters – and the poor track record of polls ahead of recent UK votes.
An agreed withdrawal deal should be good for UK equities – especially those primarily exposed to the UK economy. Many of these stocks look cheap compared to global peers. This discount could narrow if the market becomes more optimistic about an orderly Brexit. Sterling could also strengthen from current levels.
However, there’s reason to think the extent of these moves will be limited. Despite their pledge to “get Brexit done” the Conservative’s proposed deal only opens the door to the next phase of negotiations, which sees the UK turn its attention to a trade agreement with the EU. A “no-deal” Brexit could again become a possibility as we head through 2020 and towards the end of the transition period.
In the event of a secure Conservative majority, we would expect portfolios to benefit from a rise in UK stocks. However, this is likely to be offset to some extent by a rise in sterling that would negatively impact the sterling value of some overseas assets.
A Labour majority… or a hung Parliament
The market impact of other election outcomes is less clear. Investors may sell UK shares and sterling in response to a Labour majority, given the prospect of higher corporate taxes, a higher minimum wage and – in certain industries – nationalisation. The knee jerk response to a hung parliament may also be a move lower in sterling and UK stocks, as political uncertainty is likely to depress economic activity. However, both a Labour government and a hung parliament raise the possibility of a “softer” Brexit deal than the one currently on the table. Over time, this could be beneficial for UK equities and sterling.
We aim to ensure that portfolios are resilient, whatever the election result. Global developments – such as the evolution of the US-China trade war – are likely to have a greater impact.
What will happen to UK interest rates ?
UK interest rates are very low by historical standards – but unlike the eurozone, Switzerland and Sweden our central bank policy rate is still in positive territory. The Bank of England’s (“BoE”) base rate is currently 0.75%.
The last change in the rate was a quarter percentage point rise in August 2018. Odds of a move – in either direction – now appear to be rising.
Two members of the BoE’s Monetary Policy Committee recently voted for an interest rate cut, surprising markets. There would likely be more support for a rate cut if the election result prolongs Brexit uncertainty. Conversely, progress towards an orderly transition period could encourage the BoE to take another step towards normalising the policy rate.
Longer-term interest rates are also very low, with the 10-year gilt offering an annualised return of around 0.75% – close to the lowest level of the last five years.
Such low gilt yields suggest that there is very strong demand for long-dated government debt. It is likely also a sign that investors are downbeat on the long-term prospects for UK growth. This is unsurprising given that whatever happens over the next few months, uncertainty about the UK’s trading relationship with the EU will persist.
Interestingly, long-term gilt yields have not responded to pledges of higher spending from both the Conservative and Labour parties. In theory, higher government spending should mean higher long-term interest rates. It boosts growth, favouring exposure to equities over bonds. It also raises the supply of government debt – requiring higher yields to entice new buyers.
UK government bond investors may well want to see what the next government looks like – and whether it has a strong enough mandate to deliver on its spending pledges. They may also be paying more attention to global trends – such as slowing global growth and subdued inflation – than domestic ones.
Cazenove Capital does not hold political views.