Just when we learned to stop trusting the statisticians, they managed to get it right. As predicted by opinion polls and betting markets, the Conservative Party won a comfortable majority with 364 seats. The Labour Party won 203 seats, a loss of 59. The Scottish National Party built on its strength to win 48. The Brexit Party – a big winner in the European Union elections held in March – did not win a single seat. The Liberal Democratic Party won 11 seats. At the time of writing 1 seat is yet to report.
In the early hours of trading, markets have reacted positively this morning, with the sterling/US dollar exchange rate rising by 2.3% to 1.34. The FTSE 100 is up circa 1% and the more domestic-oriented FTSE 250 is up 4%. European equity markets are up 1.3% while bond yields are slightly up this morning. We attribute these moves to expectations for more-business friendly policies and less uncertainty regarding the UK’s exit from the European Union. Labour market-unfriendly policies such as nationalising industries, raising corporate taxes and increasing union powers would have weighed on company earnings.
The Conservative Party has achieved a clear majority, but it’s too early to declare “mission accomplished” for the UK. The Prime Minister, Boris Johnson, has previously said that Parliament will vote on the European Union Withdrawal Agreement bill before Christmas and leave the European Union by 31 January 2020. What comes next, though, is less clear. The focus will shift to trade negotiations between the UK and EU. A deadline of December 2020 is set to complete the trade deal. The UK can request an extension but Boris Johnson has insisted it will not. Although there are recent templates (Canada and Japan deals) that can be leveraged off, trade deals typically take years to negotiate and ratify. We are sceptical that a trade deal can be completed in a year. In addition, it will need to be ratified by all 27 EU member states leaving ample room for last-minute brinkmanship from individual countries. We think sterling’s rally could come to an end if significant progress is not made on the trade negotiations in the middle of 2020.
It’s not just about Brexit, though. How businesses, consumers and investors react over the coming months will shape the UK economy and markets. Government stimulus measures could provide a welcome boost to growth. Rate cuts by the Bank of England, although unlikely in the near term, cannot be ruled out at some point in 2020 should the growth outlook remain bleak.
Businesses and consumers
In the long run, business investment is a key driver of economic growth. The term “business investment” is broad; it covers things like buying new machinery, improving software systems, information and communication equipment, and researching new products. As 2019 comes to a close UK businesses continue to plan to reduce investment, according to a survey by the Bank of England.
Will the election outcome change the outlook for businesses? For some it has removed the uncertainty linked to some of Labour policies. For others, the elephant in the room remains Brexit and what trade relationship the UK will have in the future with the rest of the world. A move to World Trade Organisation (WTO) trade terms would be damaging for many UK businesses.
As well as keeping a close eye on negotiations between the UK and the EU, we will closely follow the UK leading economic indicators, such as the purchasing manager indices (PMIs), housing market indicators and lending figures. Consumer spending is vital to the UK economy. It has been resilient over the past year and helped prevent a recession. We expect this trend to continue for now.
The UK equity market has been out of favour with international investors since the 2016 referendum. In October 2019, a survey of fund managers by Bank of America Merrill Lynch put the UK equity market in last place for long term investment prospects; only 3% of respondents thought UK equities would deliver the best returns over the next decade.
The election result could prompt some investors to rethink their views on the UK. The exit from the EU is now clearer and voters may not go to the polls again until 2024. The question, though, is how fast the attitudes of investors will change. We think there will be momentum for UK assets in the short term. However, we think many investors may wait for further clarity on the UK/EU trade deal before piling back into UK companies.
We are not making changes to our investment strategy today. In sterling portfolios, we added exposure to the pound and domestically-focused UK companies in the summer of 2019. We continue to believe these assets will outperform in the short-run as investors reprice the end of the parliament deadlock.
We will reassess the exposure to the pound and to UK Equities in the coming weeks and months as the situation evolves. Global events, such as trade tensions and changes in interest rates, will also impact the economy so the government will need to adapt to those forces. Importantly the portfolios, while holding notable sterling-denominated exposure, remain well-diversified by assets, geographies and sectors.
Should you have any questions, please contact your usual Brown Shipley adviser.
The Investment Office
This article is for information purposes only. It does not constitute investment advice and is not a recommendation for investment. The value of investments and any income from them may fluctuate and are not guaranteed. Investors may not get back the amount originally invested. Past performance is not a reliable indicator of future results. Currency fluctuations may cause the value of underlying investments to go up or down.
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