Strong and stable – it’s a tag that will haunt Theresa May. That’s the opinion of James Gardner, head of collectives research at Alpha Portfolio Management, as he assess what last week’s election result might mean for the UK economy – and for investment prospects too.
Having called a snap general election on the mandate of a ‘strong and stable leadership’, Theresa May’s seemingly low-risk decision has spectacularly backfired, with her party failing to win a majority and leaving the country in political turmoil. A combination of policy blunders, an ill-conceived campaigning strategy and a resurgent youth vote, have resulted in a major upset, which now leaves the country faced with considerable political uncertainty. In spite of this backdrop, a resurgence in two-party politics, with the combined share of votes for Conservatives and Labour reaching its highest for a generation, points to broad political engagement by the UK population.
Considering election arithmetic, a Conservative-DUP led Government is the only realistic outcome. In spite of such a humiliating result, Theresa May appears to be hanging on as leader, at least in the short term, as she attempts to form a Government and starts the initial Brexit negotiations. Yet, with Northern Irish concerns over the border with the Irish Republic paramount, a softening of her original Brexit stance is likely.
In general, the outcome points towards more populist expansionary policies, with less political support for corporates in general, and higher earners in particular. The Government’s weak position suggests minority interests will play a key role over the next few years. However, a substantial fall in support for the Scottish National Party (SNP), replaced by pro-UK parties, removes the question of Scottish independence, for the time being.
Theresa May – PM for how long?
Given the damage to Theresa May’s credibility, it seems almost inconceivable that she can stay on in the longer term. She would, rightly, face a constant onslaught questioning her mandate and leadership, ironically the same criticism that she had previously laid at Jeremy Corbyn’s feet. However, a major concern would be what sort of candidate the Tories might put forward to replace her. A desirable outcome for the country would be a centrist, with cross-party appeal, however bearing in mind that it has been Conservative party self-interest that has got us this far, such an outcome cannot be taken for granted.
What does all this mean?
In the short term, this leaves us with government policy paralysis. Yet, it is conceivable that the result leads to a softening of views with regards to the future relationship with the UK’s largest trading partner, and ultimately a softer Brexit, which would be supportive for the UK economy.
Out of the gloom, a chink of light
Actually, we are more hopeful of the prospects for the UK economy as a result of the general election outcome. There is a risk of a short-term impact, however the ongoing uncertainty has already seen business momentum slow over the past 12 months. The most notable impact has been on Sterling, which has unsurprisingly weakened on the news. Yet with the majority of UK stock market earnings coming from abroad, the fall in the currency has typically proven a welcome development for those companies.
More domestically focused businesses have undergone a sharp de-rating over the past 12 months, as a deteriorating economic environment, including weakening wage growth, alongside rising inflation, has squeezed the UK consumer’s real income. Whilst uncertainty is likely to lead to further short-term volatility, and potentially some disappointment, valuations aren’t expensive, and we are therefore watching and listening for signs of a recovery.
Gilts looks vulnerable
This month marks the one year anniversary of the EU Referendum and consequently the inflationary impact of Sterling’s fall starts to lessen. With the upward pricing pressure of commodities also much diminished, this would imply a better backdrop for bonds. Nevertheless, it remains very difficult to find attractions to such low yields, particularly bearing in mind the prospect of expansionary policies, alongside the current position of major central banks, which are typically tightening monetary policy. In spite of the prospect of more expansionary policies, UK Gilts have remained largely unchanged – thus far. There is an increasing risk that the UK political situation could cause overseas investors to lose faith in Sterling. With 10-year gilt yields back below 1%, there is little margin for error and they could be vulnerable to a credit rating agency downgrade, with our dimming economic outlook. Additionally, if the market were to sense a more aggressive stance to expansionary stimulus, resulting in the Government further increasing its gilt issuance, the rebound in yields could be savage.
Equities, particularly Europe, remain attractive
From a global perspective, global economic indicators remain broadly positive, with earnings upgrades, particularly from Europe. Whilst global monetary policy to continue to tighten, with the Federal Reserve widely expected to raise interest rates on Wednesday 14th, generally cautious investor positioning, should mean equity markets are broadly supported at these levels.