Martin Currie's Browne Comments On UK Election

June, 2017

Seven weeks ago, UK Prime Minister Theresa May called a snap election with the aim of consolidating power for the Conservative Party ahead of negotiations to leave the European Union (EU). This high-risk political strategy has failed with the party losing its majority and the UK heading towards a hung parliament. Michael Browne, Portfolio Manager European long/short, looks at what this now means for investors and the UK economy.

Another shock election result

For the third time in three years, the UK has produced an electoral surprise. From a political point of view, we now have a weak Conservative party trying to govern, with whatever coalition can be created. The delay in forming a government may be lengthy, as Theresa May looks set to be replaced as leader. As was the case in 1974, another election feels inevitable and could well be called before the end of the year.

The message from the electorate is they wish to see more spending on government services. This means the vote is a clear call for increased fiscal spending and the markets are going to have to work out how the new Chancellor (whenever he or she is announced) will pursue this. That faster spending may well be needed, as business uncertainty caused by both this election and the upcoming Brexit negotiations is already slowing GDP growth.

The immediate implications

At a market level, sterling fell sharply, but has not fallen as low as it did following the UK’s Brexit vote last year. The bond market, meanwhile, was relatively unmoved and in equities we expect there to be some buying activity following the election result.

In the short term, key factors will be business and consumer confidence, alongside the possibility of yet another election. The UK economy had been performing better than its low post-Brexit expectations, on the back of a strong consumer, but still well below the previous five years. Consumer spending has been softening recently, under pressure from rising inflation. Inflation is peaking and any removal of the public sector wage cap would significantly lift optimism. There has been little or no reported slowdown in enquiries for new houses, for instance, and any government will be very keen to at least keep that momentum, if not announcing further measures to help or accelerate building.

The election result will not be supportive for business confidence, companies were already cautious, but will feel the outlook for a soft Brexit is higher. However, no one will invest in this outcome, until a final deal on Brexit is reached. International investors, already deterred by Brexit, have another reason for avoiding UK assets for the time being.

The impact on Brexit negotiations

The results show the population voted for the two main parties that will continue the Brexit process, rather than move towards the Liberal Democrats – who were demanding a second referendum.

With the likelihood of a new Prime Minister at the helm, any talks about Brexit are likely to lack substance. The process will start but will be very technical and the UK’s lack of authority may well mean the process has to be extended. That can only be done by a unanimous vote by the heads of all the other EU governments –  this is quite likely, however. It suits them well.

The impact on UK assets and the underlying economy

We had taken down the portfolio’s UK assets, in particular commercial real estate. We had also added to the short position in UK retailers. We have maintained the portfolio’s position in housebuilders, however. The sector is needed, whoever the winner, and with no outright victor in this case, could be even more of a focus for government support. Importantly, all policy options are now on the table, as no manifesto has emerged a clear winner. For instance, will the proposed corporate tax cuts be shelved in favour of spending on the police, NHS or education? In addition, the Conservative surge in Scotland looks to have killed off the chances of a second independence referendum – removing an extra level of political uncertainty.

For markets, the risk premium for UK assets, which was already high, has risen another notch, but not massively so. With Europe powering ahead, the UK could become a quiet backwater, of less relevance to international investors, and will remain that way, until another election is called and the results are in.