Markets on Hold Ahead of Pivotal UK Election
After what feels like a lifetime of political turmoil, the stalemate over Brexit and the UK’s future relationship with the EU may come to an end this week as Britain goes to the polls. After three and a half years of political uncertainty, which has resulted in unprecedented volatility in UK investments and the pound, markets are hoping for a Conservative majority to bring certainty to the Brexit outcome and retain domestic policy which is supportive of UK businesses.
As it stands, opinion polls suggest that a Conservative majority is the most likely outcome come Friday, but as we know from recent years, British politics remains unpredictable, and a number of outcomes are still possible. In the most recent poll from YouGov, the Conservatives are predicted to gain a majority of 28 seats, compared with 68 projected just two weeks ago. The poll, which was published last night, forecasts that the Tories will win 339 of the 650 seats in the House of Commons, Labour 231 and the Scottish National Party 41. The research used a technique that more closely predicted the result of the 2017 election than other standard surveys. The results are shown below:
The pound has climbed to near $1.32 for £1 in recent days from below $1.29 last week, as investors have grown more confident of a Boris Johnson win, but the result could still have a major impact on world markets and currencies. A Stock Market Almanac study analysed the impact of UK Election results on stock markets from 1945-2010. During this period, the Conservatives and Labour each won nine general elections. The study found that in eight out of the nine years following a Conservative victory, the FTSE All-Share index rose, with an average 10.8% gain. It also found that the market rose in just three of the nine years following a Labour win, with an average negative return of -5.8%. While this information is meaningful, none of those elections featured Brexit, and the 2019 vote will have its own set of factors and consequences for the pound.
Potential Outcomes for Markets
With the polls predicting a Conservative win, attention will turn to the size of the majority that a returning Johnson majority might hold in the House of Commons. The party needs 326 seats for a majority, but given the divisions which lie within the Conservatives, (notably with resistance from the ERG faction) a larger majority will be required to deliver further certainty on the Brexit outcome. A convincing victory would make it easier for the Prime Minister to get a Brexit deal approved by MPs and ensure Britain leaves the EU by the new 31st Jan deadline. Such an outcome would benefit domestically exposed companies in the unloved FTSE 250 rather than international companies in the FTSE 100 which would likely decline on stronger UK currency, which we see rising to $1.35 in this scenario.
On the other side, markets may consider a Labour victory as being unlikely, but Corbyn entering Downing Street would have a huge impact on both the pound and UK stocks. Corbyn’s plans for multiple nationalisations and tax hikes for businesses mean that the threat of a Corbyn government is perceived extremely negatively in markets, and the pound would likely weaken significantly on such an outcome.
A small Conservative majority, or a hung parliament would diminish the chances of breaking the Brexit deadlock. Such an outcome would see uncertainty return along with the prospect of a no-deal Brexit, sending stocks and the pound plunging.
Voting Turnout
The UK goes to the polls tomorrow in the first December election since 1923, with cold weather and early nights hampering canvassing and possibly deterring voters. With so many constituencies on narrow majorities, and so much at stake in this once-in-a-lifetime ballot, turnout may be crucial in determining the end result. By dawn on Friday morning, the results will be in, and how Brexit negotiations proceed will hang on the result.
Our Positioning
It is our view that the Conservatives will gain a majority in tomorrow’s election, however the size of that majority remains uncertain, with the gap narrowing in recent weeks. Based on that expectation, should the conservatives gain a considerable majority (or one which would neutralise the threat of the ERG), it is likely that domestic UK small and Mid Caps will benefit, while the FTSE 100 declines on a stronger pound. In this scenario, we are well positioned to benefit, with small/mid cap exposure currently within the portfolio alongside the FTSE 100 short. Should there be a hung parliament, it is likely that small/mid caps will still benefit given ambitious spending plans of all parties, however the Brexit question will remain unanswered, meaning continued uncertainty. Our portfolios remain defensively positioned, with a barbell in place which seeks to protect capital whatever the result.
Potential Portfolio Changes
In the lead up to the election, we have been considering adding to our UK small/mid exposure within the portfolio, however given the more global risk that Donald Trump could impose a new round of trade tariffs on Chinese goods on Sunday, we are holding off for more clarity on this issue before adding to our equity exposure. Markets are currently expecting the tariffs to be extended, however should they come into place, global equity markets would react extremely negatively, regardless of the UK outcome. For this reason, we intend to wait until we have clarity on whether the tariffs will come into place before we introduce these positions. Should the tariffs be extended and the election yield a Conservative majority, we will be increasing our small/mid UK exposure this week.
For more information on trade developments this week, please see the attached Market Update document.
Key Events We Are Watching This Week:
- Wednesday: US Fed Interest Rate Decision
- Thursday: UK General Election
- Thursday: ECB Interest Rate Decision
- Sunday: Planned US Tariffs on Chinese goods come into place (unless extended)
For anyone who wants further data to substantiate the position please review the attached Global Economic Update document and the Economic Dataset also attached.
Model Portfolios & Indices
Global equity markets demonstrated a high level of volatility over the week amid growing global trade tensions centred around US-China trade talks, while UK markets were dominated by political news and subsequent sterling movements prior to this week’s general election. Safe haven assets, such as gold gained over the week as investors moved out of equity markets and turned to lower risk opportunities. The OBI portfolios remain defensively positioned with limited equity exposure, and our portfolios remain well positioned given current conditions. The portfolios gained over the week owing to the defensive positioning, with changes made in recent weeks expected to continue to provide further support to portfolio performance going forward.
As we progress from here, it is important to recognise that we should not let benchmark performance make us feel like we have missed out on anything, because although we have in the short term, recent performance shows how quickly this can be reversed given current levels of risk and uncertainty.
Overall, it is our view that equity markets will continue to decline before adjusting to the new norm based on lower global growth and weaker corporate profitability. The key point here is to take a long-term view, look at the current level of uncertainty in the global economy, and remember that the portfolio is designed to minimise your exposure to risk and preserve capital. Markets are behaving irrationally, therefore the most sensible strategy is a defensive one given current market conditions.
Important Information
The data above will not directly correlate to the indices as there is always a delay in pricing because the US markets close significantly later than the European markets and the Asian markets. The data set above reflects the last close and much of the day’s movements will not yet be reflected in the portfolios due to pricing delays. You cannot therefore directly correlate indices to the portfolios. The value of investments may fluctuate in price or value and you may get back less than the amount originally invested.
Past performance is not a guarantee of future performance. Performance figures quoted include the fund manager charges but exclude other fees such as adviser, custodian, switch and/or discretionary investment management fees. Unless otherwise instructed and accrued, income is reinvested into the portfolio.
This Day in History
On this day in 1936, King Edward VIII announced in a radio broadcast that he would be abdicating the British throne to marry American divorcee Wallis Simpson. He became the only British sovereign to voluntarily resign the crown.
Have a great week,
Jason & Gina
