Personal Investing
Tom Stevenson, Personal Fidelity Investing 13 Jun 2017 01:13pm

Markets face new uncertainty as May's gamble fails

SPONSORED FEATURE: The prime minister’s electoral gamble has failed spectacularly to deliver her the mandate she was seeking and investors are now braced for volatility after a period of unexpected calm

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Caption: UK assets face stiff headwinds after electoral shock.

As with last year’s referendum, however, the market’s response to an unexpected political outcome has itself been a surprise. Markets are said to hate uncertainty but the FTSE 100 reacted to political stalemate with a rise of more than 1%.

If investors have learned anything over the past year it is that it is often better to look through short-term political turmoil to focus on longer-term goals.

Having called a snap election to cement the government’s authority, Mrs May has not only failed to extend her wafer thin parliamentary majority but she has lost it altogether. Of all the potential results, a hung parliament in which no party can claim more than 50% of the 650 available seats, might be seen as the worst of all possible outcomes from an investor’s perspective.

Indeed, as soon as the exit polls started to point towards an indecisive result, the pound - the traditional lightning rod for political uncertainty - started to weaken. Sterling fell from nearly $1.30 to $1.27 in overnight trading, although this paled in comparison with the 11% drop in the pound in the hours after last summer’s EU referendum shock.

When markets opened in London, however, the FTSE 100 index actually rose by more than 1%. This is a reflection of the positive impact of a weaker pound on Britain’s largest exporters and overseas earners. The more domestically-focused FTSE 250 index, which investors consider more vulnerable to uncertainty or weakness in the UK economy, slipped by 0.5%.

Even though the government was widely considered to have fought a poor election campaign, the opinion polls pointed to a Conservative majority right up until the polls closed. Markets were positioned for that outcome so the mixed response has been unsurprising.

Attention is now focused on what the election result will mean for the Brexit negotiations which are due to start in ten days’ time. Speculation is rising that the new political arithmetic could force the government into a ‘softer’ Brexit that includes continued membership of the Single Market or Customs Union. But there is a valid counter-argument that the government’s likely dependence on the support of Northern Ireland’s Democratic Unionist Party could lead to a more uncompromising Brexit deal.

Indeed it is unclear even who will be leading the talks on Britain’s behalf following calls for the prime minister to consider her position in the wake of what many see as a spectacular political miscalculation.

The political uncertainty triggered by last night’s vote adds to an existing sense that the UK is a relatively unattractive investment destination. The London stock market has risen since last year’s referendum to all-time high levels on the back of sustained weakness in the pound, which has boosted the competitiveness of British exports and increased the value of the overseas earnings of UK companies. In the view of many observers, that has made UK shares vulnerable to a correction but continued sterling weakness could boost Britain’s international blue-chips further.

The outlook for the British economy has also deteriorated in recent weeks as the inflationary impact of sterling’s weakness has combined with sluggish household earnings growth to deliver an effective pay cut to British workers. This has brought to an end a period in which the UK economy has outperformed expectations.

With Britain’s political and economic woes largely self-inflicted, investors should be able to protect their portfolios by ensuring that they are well-diversified, geographically and by asset class. With the global economy generally improving, a well-balanced portfolio of investments should not be unduly affected by the UK’s local difficulties.

The strong returns of the past 12 months, when expressed in sterling terms, have underscored the merits of holding a broad spread of investments. UK investors do have a tendency to overweight domestic holdings in their portfolios - an effect known as ‘home bias’ - but Britain’s challenges are not new so many investors will have already reduced their exposure to home-grown investments.

Compared with the seismic shock of last year’s decision to leave the EU, with its implicit threat to the whole European project, this week’s election result is probably less globally important than the referendum. But it is bad news locally. With plenty of other more attractive options, few international investors will see the need to invest in the UK for the foreseeable future.

One final implication of this latest political shock is almost certainly a complete rethink of the government’s austerity programme. The Conservatives completely misread a sea-change in the British public’s attitude to spending cuts while Labour’s Jeremy Corbyn instinctively understood the shift in sentiment.

That itself will have longer-term market implications. Focus on the deficit will most likely be abandoned, resulting in less fiscal discipline and more issuance of government bonds and rising yields.

So the message to investors is simple. Be well-diversified, favour equities over bonds and, within the UK, prefer the international-facing FTSE 100 to the more domestic FTSE 250.

Tom Stevenson

Tom Stevenson

Tom Stevenson has been writing about investment for 25 years. Before joining Fidelity International in 2008 he worked at Investors Chronicle, The Independent, Hemscott and the Telegraph, where he continues to contribute a popular weekly column on the markets.

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