The first December General Election since 1923, and the third in the last five years, has produced a Conservative majority on a scale that has not been seen since Margaret Thatcher’s 1987 victory. With the majority of seats having been declared, the Conservatives are expected to win 364 of 650 (a gain of 46 on the 2017 general election), while Labour are expected to hold just 203 (59 fewer than 2017). If correct, this would give Conservative Prime Minister Boris Johnson a 78-seat majority.
This election is arguably a reflection of the extent to which voters were pulled from their traditional voting allegiances to coalesce around their Brexit view. The Liberal Democrats are expected to win 11 seats, one fewer than 2017, showing their failure to convert the remain vote. This is further illustrated by party leader Joanne Swinson losing her seat to the Scottish National Party (SNP). In contrast, the Conservative and Labour leaders have both retained their seats, although Jeremy Corbyn has said he will not lead his Party into a future general election (albeit he will not resign as party leader immediately).
As well as the good result for the Conservatives, there has been strong performance from the SNP, which is set to win 48 of a possible 59 Scottish seats, compared to 35 in 2017. The Party campaigned largely on the basis of a second Scottish independence referendum. Just as Prime Minister Johnson will claim to have a mandate to push his vision of Brexit through Parliament, this will add weight to SNP leader Nicola Sturgeon's demands for a second Scottish independence referendum. However, the Prime Minister has asserted that he will block any attempt to hold a second Scottish independence referendum.
Ultimately, some of the near-term uncertainty surrounding UK politics has now been removed. With Prime Minister Johnson having reduced dissent within the Conservative Party since becoming leader in July, we now expect the Government to pass his Withdrawal Agreement and for the UK to leave the EU by 31 January 2020, as he has promised. More broadly, Johnson is expected run a moderate Conservative administration, with some of his more economically-orientated campaign pledges including a commitment not to raise taxes, while enacting tax cuts for low earners, and increased housing and infrastructure investment.
This morning’s news has been priced into asset markets through sterling, which has appreciated from under 1.32 to over 1.35 temporarily against the US dollar; at time of writing it is trading closer to 1.34, a rise of over 2%. Sterling has also risen from around 1.18 to over 1.20 against the euro. Considering the surprise scale of the Conservative majority, it could be argued that sterling’s rise looks modest; this likely reflects the speed at which markets will move on to consider what comes next. The focus now will be on the UK-EU future trading relationship.
UK large-cap equities are trading marginally higher. UK domestic equities are also expected to react positively to the large Conservative majority, though the valuation discount of UK domestic equities relative to UK internationally-exposed equities has already narrowed in the weeks leading up to this election. These moves are in context of positive global sentiment associated with news regarding the US-China trade negotiations. In fixed income markets, ten-year gilt yields moved slightly higher.
Today’s result has provided some short-term political clarity and we now expect the UK to leave the EU on 31 January 2020. This should be supportive for UK assets, including sterling, in the short term, as demonstrated by this morning’s market reaction.
Despite this, we caution against expecting a sustained improvement in the investment environment. Investor attention will quickly turn to uncertainty surrounding the future trading relationship between the UK and EU. With such a large majority, Prime Minister Johnson may be emboldened to pursue his vision of a radically different relationship with the EU and markets will be mindful that the political brakes from a weakened opposition in Parliament will be off. Should a trade deal not be in place or an extension agreed by the current transition period deadline of 31 December 2020, the UK will revert to World Trade Organisation (WTO) rules with the EU. This would mean the introduction of tariffs and other anti-growth trade barriers. So far, the Prime Minister has refused to countenance an extension to any transition period and it will be up to the Conservative government to request one by 1 July 2020, if necessary. While markets were relieved to see the Prime Minister pull back from his ‘do or die’ political claims in October, markets will be mindful of the risks associated with any new cliff edge.
We are sceptical of the Prime Minister’s assertion that no extension to any forthcoming transition period will be necessary, particularly given how much he wants to diverge from the EU rule book. We consider it optimistic to expect the UK to reach an agreement with the EU in just eleven months, given it took Canada and the EU around eight years to sign their recent deal. If it appears trade negotiations are not progressing as hoped, uncertainty will increase once again. This could create further headwinds to consumer sentiment, business risk appetite and, therefore, economic growth. The difference now is that it is in context of the UK economy having just suffered its worst three-month performance for more than a decade.
We are cognisant that government spending is set to rise under the new government. This should provide a boost growth, but it might also stimulate inflation. It is possible that we will see a situation similar to that of President Trump and Federal Reserve Chair Powell in the US, with the Conservative government providing additional fiscal spending, while the Bank of England acts to curb credit growth and economic enthusiasm by raising interest rates. Equally, against the more balanced policy outlook communicated from the Bank of England recently, they might be tempted to stay their hand on interest rates until further clarity is provided on the forthcoming UK-EU negotiations.
On most metrics, the UK equity market is cheap. It is currently trading at around 12.3x one-year forward earnings, a discount both to Europe and the United States. At the same time, its dividend yield of around 4.7% is attractive for yield-hungry global investors. That said, the UK’s economic outlook remains cloudy.
Given the risks, we remain cautious on UK assets over the medium term. We recognise that an important step looks to have been taken and that short-term clarity on Brexit will be helpful, but the shape of the future trading relationship will be pivotal. It is likely that UK political risk will continue to dominate the investment landscape well into 2020…
The performance indicated for each sector should not be taken as an expectation of the future performance. Investors should be aware that the price of investments and the income from them can go down as well as up and that neither is guaranteed. Past performance is not a reliable indicator of future results. Investors may not get back the amount invested. Changes in rates of exchange may have an adverse effect on the value, price or income of an investment. Investors should be aware of the additional risks associated with funds investing in emerging or developing markets.
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