In his book, The Long and the Short Of It, economist John Kay recalls his decision to invest in shipyard Robb Caledon back in 1976 in his chapter outlining risk and reward.
At the time, a bill was going through parliament to nationalise British shipbuilding under a Labour government led by James Callaghan.
If the bill went through parliament successfully, shareholders would have been compensated with 100p per share. If the bill failed, shares would be worthless as the company was “on the verge of financial collapse”, Kay explains.
He argued that as his personal probability of the bill being passed was higher than 50% and the potential payout was 100p, the stock, then trading at 40p, was a good buy.
While that decision may be over 40 years old, it’s a scenario investors may need to revisit in the coming months. Jeremy Corbyn is currently the favourite to become the UK’s next Prime Minister.
Morgan Stanley reckons that’s likely to happen this year. Many agree and David Coombs, head of multi-asset investments at Rathbones, says investors should take steps now to protect their portfolios. Meanwhile, investment manager Psigma says UK financial markets are under-pricing a potential Corbyn premiership.
In a note to clients, the investment bank said the prospect of Corbyn becoming PM is a more serious threat to British business than Brexit. The threat of nationalisation would hang over key industries and corporation tax would likely be hiked to 26%, from 19% today.
Colin Morton, manager of the Morningstar Silver-rated Franklin UK Equity Income Fund, says these policies would have “severe repercussions for the UK equity market”. Shadow Chancellor John McDonnell has already admitted we’d see a run on the pound should his party gain power.
That’s good for large-cap international stocks like Shell (RDSB) and Diageo (DGE), says Morton, as the majority of their profits come from overseas. “Yes they’d have to pay a bit of an increased corporation tax, but it would be on a very small part of their business.”
But those FTSE 100 companies whose profits overwhelmingly come from the UK, like retailers, would have a double-whammy of higher taxes and higher import prices.
Coombs agrees, noting a Corbyn government does not necessarily mean the UK’s blue-chip index, currently trading at record highs, would fall. His strategy would be to “avoid any company that has 80%-plus revenue coming from the UK economy and avoid high-yielding equities”. He adds: “You probably look to invest in the overseas earners in the FTSE 100, which there are a lot of.”
Threat of Intervention Looms Over Equities
Those industries most at risk of nationalisation would be utilities, railway firms and mail services. Morton says the utilities tick many of his boxes, especially as they pay high, inflation-protected dividend yields.
However, due to the sector being “used as a political football”, he’s significantly reduced his exposure recently. The prospect of the government taking control doesn’t help the investment case.
Ben Edwards, manager of the Morningstar Bronze-rated BlackRock Corporate Bond fund, would be surprised if nationalisation on this scale would be implemented, “not least of all because the price at a time when the UK government is likely to be struggling fiscally seems wholly unlikely”.
But Coombs notes that the UK Prime Minister potentially has a lot of power. “If Labour got in with a decent majority, they have much more chance of doing the nationalisation,” he says. In fact, nationalisation doesn’t have to cost anything, though it’s unlikely investors wouldn’t be compensated.
“I suspect they will have other priorities, but they have the power to do it,” says Coombs. “Look what the Wilson government did in the 60s and into the 70s, which didn’t end particularly well.”
As a consequence, Coombs suggests investors should ignore any sector where there’s a threat of interventionism. That includes water companies, rail companies, bus companies, infrastructure companies – “you’re not going to buy a lot”.
In a note on the UK capital goods sector, broker Barclays says defence stocks like Ultra Electronics (ULE) and Chemring (CHG) would suffer. However, industrials would be winners on a relative basis due to their low exposure to the UK consumer. These include Laird (LRD), Bodycote (BOY), IMI (IMI), Spectris (SXS) and Renishaw (RSW).
Expect Gilt Yields to Rise Sharply
On paper, a rise in taxes would raise income for the government, which would help with Labour’s spending plans and reduce reliance on the "magic money tree". However, Coombs says this is unlikely to be the case in practice.
Although it looks good politically, raising taxes would actually reduce the tax take, he says, because the UK culturally isn’t a high-tax economy. “Voters won’t put up with it and people will leave. We can bash the bankers and raise corporation tax; that doesn’t mean you raise another penny and certainly not enough to fulfil all the spending pledges.”
The other way the government can raise cash is to borrow. “What does that mean for your borrowing costs? They go up because the more you borrow the higher your interest rate goes.”
As a consequence, Coombs expects gilt yields to rise dramatically. Combined with another fall in sterling, the ultimate result could be stagflation, he adds – an unwelcome combination of a weak economy and high inflation. In that environment, you can add sterling fixed income products to the list of assets you shouldn’t be holding.
There is a bull argument, says Coombs, that investing aggressively in the economy would create more demand and people pay more taxes. However, that would be more likely if were we in a deep recession, rather than at near-full employment.
According to the Betfair Exchange, there’s around a 50% chance of a general election in either 2018 and 2019.
A poll run by research agency Populus for the Legatum Institute think tank showed the public overwhelmingly supported nationalising water, electricity, gas and trains and was split 50/50 on bringing banks into public ownership. So a Corbyn government should be something investors should at least keep at the back, if not the forefront, of their minds.
