It is fair to say that few people predicted the outcome of last week’s snap election. Financial markets don’t usually like surprises. There were significant corrections in both currency and stock markets following similar ‘upsets’ last year, after the EU Referendum and US Presidential election.
But markets barely moved after the result of the general election – which ended not with the predicted Conservative landslide, but with a hung parliament. Why have they been so quiet?
Prior to the EU Referendum, bookies were pricing in a 90% chance of the vote going ‘Remain’. Similar odds were given on the Democratic candidate Hillary Clinton beating Republican rival Donald Trump for the US presidency. Both were wrong. Following the Brexit vote sterling fell by more than 10% overnight and, initially 8.7% was wiped off the value of the FTSE 100.
Markets were similarly volatile after Trump’s presidential win: with a fall in US stocks to begin with, followed by a big market surge, as people started to price in the effects of his promised economic stimulus.
With last week’s general election bookies were pricing in a 78% chance of a Conservative majority, according to Betdata, with just a 18% chance of a hung parliament. But overnight, when it became clear the latter was the outcome, sterling fell just 2% - from $1.29 against the US dollar to $1.27.
The next day, the FTSE opened up 1% - and changed little during the following day. Gilt yields barely moved.
The Result Meant Only Limited Change
Trevor Greetham, head of multi asset with Royal London Asset Management said: “What happened last week was hardly anything. Even for sterling this was a small move down and the FTSE 100 went up slightly in response.” He said although the result was unexpected, the market could see from the way the voting went, that a minority Conservative government was the likely result. In other words the Conservatives would remain in charge, and there may be limited political change.
However, the markets may have look more favourably on the changes that would occur as a result of the Conservatives moving from majority to minority government. From a Brexit perspective, this may weaken their negotiating power, and could suggest a ‘softer’ Brexit deal.
Paul Mumford, fund manager of the Cavendish Opportunities fund said this may be a relief for many, particularly those working in the City, and may have contributed to a calmer market reaction.
“The UK government’s negotiating power weakens by having a smaller majority. This might cost the country’s economy more, but from a corporate point of view it might bring a little relief.”
Mumford added that the main UK stock market index is more affected by any move in sterling, than by the domestic political situation. “The FTSE 100 has a lot of overseas earners that benefit from a weaker sterling. Sterling might stay lower for longer than it would have had the Tories won a big majority,” he added.
However, it is possible that Theresa May can continue to press ahead with the current Brexit strategy, said Greetham.
“This is what we expected before the snap election. But we should watch out for moments of stress in the negotiations, as this could result in another slide of the pound.
“In this scenario, what the market is most worried about is the risk of leaving without a deal. But it is hard to imagine the deal so bad, that no deal becomes the better option. No deal is the worst deal you can imagine,” said Greetham.
What If The Brexit Terms Change?
The hung parliament increases the chances of more cross-party involvement in the Brexit negotiations. This could result in the UK staying in the single market, Greetham added, although he added such an outcome is still far from likely.
“As both party leaders want to leave the single market at the moment that will require a rebellion from the ranks of both Tories and Labour party to get a softer Brexit. But it seems to be at least plausible at the moment that this could happen.
This could mean a stronger pound, but this may have a knock-on effect on share prices.
“If you got a soft Brexit, and the pound went up 10%, it means quite low returns for multi-asset funds, because all of the overseas assets will be priced down. Many of the FTSE 100 shares are mainly overseas, so they will probably struggle,” said Greetham.
The Danger of a ‘Coalition’ Breakdown
As a result of losing their majority, the Conservatives now have to rely on the support of 10 Democratic Unionist Party MPs. Rather than being a full coalition this agreement is being done on a ‘supply and confidence’ basis, which should ensure DUP support for key legislation, such as passing the Budget and Queen’s Speech. Mrs May will remain as prime minister but DUP support will be central to the survival of a Conservative Party administration.
If this arrangement breaks down, the market will see more volatility. Greetham says investors are likely to be concerned whether the Labour Party, under Jeremy Corbyn can for a minority Government - and if so, what implication his policies might have on corporate profits.
“If there is a Corbyn coalition, you will see a major market movements: including a much weaker pound, and a big reaction in the stock market. Greetham says he expects the shares Royal Mail or water companies to be negatively affected, as the Labour Party manifesto contains plans to re-nationalise these industries.
Greetham said: “It is general the rule that if the government nationalises companies, they don’t do it at current market prices, they do it in a lower level. It’s likely the share price of Royal Mail and water companies would fall on fears of a Labour-led government.”
Even in the event of a Labour-led coalition with the SNP or Liberal Democrats, Greetham said he expect these sectors to be impacted - even though these other parties do not support nationalisation. “I think the pound could be weakened as well with the uncertainty, as this may be hard for a coalition to manage,” he added.
The Labour’s manifesto proposed a series of tax hikes, with a 45p rate of income tax on those earning more than £80,000 and a 50p tax rate for those on £123,000 or more. It also included a corporation tax hiked from 19p to 26p in the pound.
“A hike in corporation tax would have a negative effect on company earnings and sentiment, while a rise in personal taxation would send out a negative signal for companies seeking expansion in the UK,” said Cavendish’s Mumford. This could further impact stock markets.
