In the latest of a string of political shocks, the UK electorate appears to have turned on the incumbent government, denying the Conservatives a majority by delivering a hung parliament. Having started with a strong focus on Brexit and amid accusations of opportunism by the Conservatives, the nub of discussion turned over the last seven weeks towards austerity and security. The situation is developing rapidly, but as we write, it seems likely the Conservatives will be able to hold on to power through some arrangement with the Democratic Unionist Party. Below we discuss what transpired and the impact we see this having.
Yet again, the pollsters and bookies appear to have had a bad time of it in aggregate. With hindsight, it seems clear some of the consistently outlying polls had picked up on something, and the trend of polls did highlight the eroding Conservative lead.
In the final opinion polls on Wednesday, the lead ranged from 12% down to just 1%. However, it is much harder to turn these polls into actual seats in parliament due to our first-past-the-post system, with the tight polls adding to the recent volatility. Just ahead of the election, the average implied Conservative majority was 36 seats, though with a full range between a 78-majority and a 14-seat shortfall. In the final showing, the Conservative lead fell to just 2%, with 42% for the Conservatives and 40% Labour, leading to an expected 7-seat shortfall – within the range of expectations, albeit with lower conviction.
Away from the opinion polls, the bookmakers were also indicating a strong likelihood of a Conservative majority, with the odds implying an 80-90% probability on the day of the election (Source: Oddschecker). Taken together, therefore, expectations broadly – and therefore in markets – were for some level of Conservative majority, and the surprise has already had an impact.
It is far too early to make much of a meaningful market interpretation. What we do know is that this outcome probably has the greatest uncertainty attached to it, and that, in turn, will likely lead to a period of heightened volatility until we have clarity.
The immediate impact was on currency, with sterling selling off sharply as the exit poll, released at 10pm gave the first solid indication of a hung parliament.
Whilst the fall has been steep in the very short term, losing between 1.5-2.0%, it should be seen in the wider context – it is still comfortably above the post-Brexit low of US$1.20, and in reality has done little more than reverse the premium the currency has been receiving since the General Election was announced in April. The equity market opened marginally up, whilst gilts were slightly softer.
With no party having an overall majority, there will now follow a rapid period of negotiations with a view to achieving some sort of workable agreement – either a formal coalition, or a minority government working on a less formal basis. Theresa May remains Prime Minister in the interim, though there is now a question mark as to whether this disastrous result for the Conservatives will lead to her resignation. From here, there are several deadlines involved – the new Parliament needs to meet on Tuesday 13 June, requiring some form of government. However, it is possible that no-one can form such a government, in which case the next test is on Monday 19 June, when the Queen’s Speech effectively acts as a vote of confidence. Failure here will initiate a countdown of 14 days before a fresh General Election will most likely be triggered.
In reality, the most likely course from here is that the Conservatives come to an agreement with the Democratic Unionist Party, which has 10 seats, giving it a total expected voting bloc of 329 seats (326 is needed for a majority), although this could either be a formal coalition or a looser arrangement with the Conservatives as a minority government. Prior to the election, there had been talk of a ‘progressive alliance’ of Labour, the SNP and the Liberal Democrats, but the numbers make this much less likely now.
Whilst clearly a surprise, the outcome is not as market-unfriendly as it could have been, particularly given the likelihood of a continued Conservative-led government. We therefore see little change to the legislative outlook, though some of the more aggressive Conservative plans may need to be abandoned. At the same time, the risk of higher corporate taxation and a significantly wider deficit has dissipated. From an EU point of view, the collapse of the Conservative majority could lead to a softer stance on Brexit, which is likely to be taken as market-positive.
There are still clear risks from this result. In the short term, uncertainty whilst party negotiations go on could fuel market volatility. It is also important that Brexit negotiations, due to start on Monday 19 June, are not delayed significantly, given the magnitude of the task. The ongoing political uncertainty will also remain an ongoing risk – coalitions or minority governments are inherently less stable than outright majorities, making a full five-year term much less likely. Current Prime Minister Theresa May is also likely to come under a lot of pressure based on what is a disastrous result from her party’s point of view – if she stays on, a leadership challenge is likely to be in the back of people’s minds constantly.
Taken together, there is every reason to believe sterling will remain range-bound near current levels – lower than when the General Election was first announced given the ongoing political uncertainty, but higher than the post-Brexit depths on the softer-Brexit outlook. The legislative and fiscal outlook remains business friendly, whilst the fall in sterling will boost overseas portfolio exposures, and we expect our UK equity funds to benefit from the translational effect of overseas earnings in underlying companies.
Whilst highly relevant to UK investors as citizens, the overall impact of this election result is minimal for the portfolios that we manage. Our philosophy and process favours diversifying geographically as well as by asset class, and the drivers of long-term performance will be the larger macroeconomic themes and global market dynamics that we discuss in other publications, and which local UK politics are very unlikely to have a material impact on.
Where there is an impact, mainly through UK equity exposure, we have a constructive outlook for the market, which itself benefits more from the global economy than the domestic economy, and where we favour managers who are able to find high quality and value-adding companies.
We hope you have found this election update helpful. Please do get in touch if you have any questions or would like more information.