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The UK election: predicting potential market scenarios

By Elena Berton

We look at the potential scenarios for investors trading ahead of the UK’s general election next week

With less than a week to go until the UK general election on December 12, investors and traders are attempting to predict the outcome of the vote, which could end three years of Brexit uncertainty – or plunge the country and markets into deeper chaos.

While several parties are running in England, Wales, Scotland and Northern Ireland, the five main players are the conservative Tory party, left-wing Labour, the centrist Liberal Democrats, the single-issue Brexit Party and the pro-EU Scottish National Party.

Opinion polls suggest a victory for Prime Minister Boris Johnson, the Conservative candidate, although the lead he holds over Labour’s leader, Jeremy Corbyn, has been narrowing in recent days.

Still, the Tories’ current 11 per cent lead over the Labour party would be enough to command an overall majority in parliament.

Opinion and exit polls have predicted the results of general elections in the UK with varying levels of accuracy. In 2010 the exit poll was spot-on with its indication of a hung parliament, but it failed to predict a Tory majority in 2015 and wrongly predicted a Tory lead in 2017. British pollsters also got the outcome of the 2016 referendum wrong.

“The polling is following a very similar pattern to what we’ve seen in 2017,” said Jordan Rochester, currency strategist at Nomura. “A lot of [polls] got it wrong last time. I have a healthy dose of scepticism.”

Brexit question mark

The trend in previous elections has been for stock market to rise for Tory wins, and fall for Labour wins. However, none of those elections featured Brexit, and the 2019 vote will have different effects on equities and sterling.

“Whichever party wins it will surely lead to higher government spending and remove a major uncertainty from the system as the current minority government would find it impossible to rule effectively,” Paul Mumford, of Cavendish Asset Management, told Bloomberg.

“Companies would be able to plan ahead knowing that the country would be in for a period of stable government,” he added.

Each potential outcome comes with risks for investors, including the risk of a hung parliament.

The country’s political parties remain split between supporters of remaining in the EU and those in favour of Brexit, which may limit the likelihood of a clear direction for voters and markets alike.

Labour win scenario

Although opinion polls say an outright Labour victory is not on the cards, a win should not be ruled out given the unexpected outcome of recent elections and the Brexit referendum.

A clear majority would hand Labour the green light to launch its economic agenda of tax hikes and renationalisation of key infrastructure companies.

The move would bring Royal Mail, railway firms, energy suppliers and water companies, among others, into public ownership. These firms account for around 9 per cent of the UK’s yearly economic output, according to the Confederation of British Industry.

Labour’s pledge to pay less than market value for the companies would leave shareholders – and the leading FTSE 100 and FTSE 250 indexes – potentially facing huge losses.

Labour could also bring telecoms company BT under partial state ownership as part of a promise to provide every household with free broadband by 2030.

“In light of the election, we need to balance the probability of a Corbyn government. Yes, we’ve incrementally shorted some utility companies over the last week or so,” said Luke Newman, portfolio manager at Janus Henderson.

The FTSE 100’s oil and gas majors would also be hit by a £11bn (€13bn/$14.5bn) one-off tax to finance the creation of a million “green” jobs.

Good for “green” sector, bad for sterling

On the other hand, Labour has pledged to create a Sustainable Investment Board to funnel funds for fighting against climate change. This could be good news for ethical or sustainable funds that invest in companies that will benefit from interest in this area.

The party has also pledged to create a £250bn (€296.6bn/$328.4bn) Green Transformation Fund dedicated to renewable energies and transport.

A Labour victory would remove much of the downside Brexit risk, but also “probably play badly” in the markets, according to consultancy Capital Economics. This could lead to slightly higher bond yields, a fall in the pound to about $1.20 and a decline in equity prices of more than 10 per cent.

Ruth Lea, economic adviser to Arbuthnot Banking Group, reckons a Labour government would be a worst-case scenario, saying the pound could “sink to $1.15 or lower,” driving up the cost of imports.

A softer Labour Brexit

In case of victory, Labour has said it would renegotiate Johnson’s Brexit deal to keep the country in a closer trading and regulatory relationship with the EU.

Jeremy Corbyn has also promised a new referendum in June 2020 to give voters a “final say” on whether the UK should remain in the EU.

A “softer” Brexit or a decision to remain would be the best-case scenario for markets and the eurozone, according to investors’ UK general election predictions.

Jordan Rochester, FX strategist at financial services firm Nomura, said Labour’s policy to hold a second Brexit referendum would be a “big positive”.

Tory win scenario

Peter Fitzgerald, multi-asset CIO at Aviva Investors, sees more than a 20 per cent chance the UK will opt for remain. Trading ahead of the general election, he has now gone long on sterling after having broadly been short in the last five years.

Boris Johnson’s Conservatives appear to offer the more market-friendly policies and greater certainty on the timeline for an orderly exit from the EU.

This perception has been reflected in the movements of the sterling, which hit $1.30 this week as polls pointed to a Conservative victory on December 12.

The pound has gained almost 10 per cent from the lows it hit in August against the euro, while its gains against the dollar have reached 7 per cent since October.

Best for business and sterling

UK companies focused on the domestic market – which make up the majority of the FTSE 250-listed companies – should rally significantly if the election results in a Brexit under a re-elected Johnson government. Housebuilders, leisure, consumer, real-estate and bank shares would rebound substantially, according to Andrew Coury, strategist at Liberum Capital.

A majority for Johnson would make it easier for the prime minister to get a Brexit deal approved by parliament and ensure the UK leaves the EU by January 31.

ING’s chief EMEA FX strategist Petr Krpata said such a scenario would see the pound reach $1.33 over the next couple of months.

Goldman Sachs economists have predicted that leaving the EU in an orderly fashion would probably bring a relief rally in sterling to around $1.35 and 0.82 against the euro.

However, if the pound soars, the FTSE 100 Index may become less appealing to investors because its multinational companies make their money abroad in foreign currencies, according to Interactive Investor’s head of investment Rebecca O'Keeffe.

While a clear Tory win would remove the immediate uncertainty over the timing of Brexit, it would raise questions about the subsequent trade talks.

Tory Brexit risks

The Tory party has promised to negotiate a new trade deal with the EU in 2020, yet it has ruled out any extension to the transition period into 2021.

Analysts at finnCap have warned that this could “paradoxically bring about the worst Brexit option for business in the form of a ‘hard’ exit, either on January 31 or December 31 2020 if no trade deal is agreed”.

Once the transition period is over, the UK would have to strike trade deals with the rest of the world. However, if these deals take longer than expected, businesses could decide to hold off on much-needed investment, weakening growth and hurting markets even more.

Sonja Laud, chief investment officer at Legal & General Investment Management, told Reuters that markets did not appear to have thought much about what would happen after January, assuming Brexit happens, and predicted they would do so only after the election.

Pascal Blanque, Amundi’s chief investment officer, said the fund had been moving away from UK assets in trading ahead of the UK election. “It will be a long journey and Brexit itself – the discussion with the EU – will also be a long journey,” he said.

FURTHER READING: Brexit jitters put brakes on UK house prices

FURTHER READING: Musk says Brexit uncertainty was part of decision to locate factory outside UK

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