UK election: a political miscalculation

09/06/2017

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It was during a walk in Wales when Theresa May supposedly decided to go to the polls. This has proved to be an extraordinary miscalculation that has not only put her own position as Prime Minister into question, but has also thrown the UK into another period of political uncertainty on many fronts.
 
In numeric terms, it looks like the Conservatives will end up with around 318 seats, eight short of the 326 that would have been required for a majority. A deal with the seemingly willing Democratic Unionist Party (DUP), which won 10 seats, looks at first glance to be the most likely outcome; this would be just enough to see a minority Tory government, or the formation of a Tory-led coalition. Labour, notwithstanding their much better-than-expected result, seem less likely to be able to form some sort of a 'rainbow coalition', especially given the collapse in support for the Scottish National Party (SNP) and the unwillingness of the Liberal Democrats to be part of another coalition government. However, Labour, led by Jeremy Corbyn, will undoubtedly be emboldened by this result and will be in a stronger position, both in the House of Commons and in the run-up to the next election, whenever that will be.
 
What does this mean for markets?
 
The equity market reaction is likely to be far more contained (to the region in question – the UK) than both the unexpected Trump election and the now largely resolved period of political uncertainty that occurred in the run-up to the presidential elections in France. The reaction of the UK equity market will be driven by two major considerations. First, the perception that we will be entering a more uncertain political environment (which we expect to be negative for domestic equities and sterling), and second, that the government's Brexit stance may be somewhat softened (open for debate, but it would be potentially positive for domestic equities and sterling in the longer term).
 
I would expect the market to focus on the former in its initial reaction. However, as with the morning after the surprise Brexit result, we are likely to see the combination of sterling weakness (it is down almost 2% versus the US dollar as we write), UK domestic stocks underperforming (banks, real estate, utilities, retailers, etc) and international-facing business outperforming (oil & mining companies, consumer staples, pharmaceuticals). We could well see a positive FTSE 100 reaction as the international businesses, which account for a large portion of the index, rally in sterling terms. But don’t be fooled that this is anything other than the worst possible election outcome for the UK.
 
 
Glossary:
 
Rainbow coalition: a political alliance formed of several different parties.
Weighting: exposure to a particular country, sector or stock.
Domestic equities: Companies that derive a significant proportion of their earnings from domestic markets.
 
 
 
 
 

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