By Amanda Burdge
Investors always say that markets fear uncertainty. So, with a general election “too close to call” one might have expected to see more volatility in recent weeks. However, there is no sign of a sell-off in equities (or gilts).
One possible outcome of the election is a minority government. The last general election that produced a minority government was in February 1974. Harold Wilson’s short-lived Labour administration saw the stock market fall dramatically, almost halving in value, in the months after the election, but these were different times and even the most cynical political commentator would not blame the stock market fall of 1974 on the minority lead government; there were bigger global economic issues at play.
Today we are in different economic times. Inflation is officially measuring zero (closer to 20% in 1974), oil prices have halved (1974 saw oil prices quadruple as production was cut) and we are not in the midst of a global recession like 1974, instead we are on our way to recovery.
Is the strength of the economy the reason that markets have failed to fear the election? Or perhaps the global nature of the FTSE?
Some had expected the prospect of a referendum on EU membership (if the Conservatives win the election) to increase market volatility now. Whilst it is true that a referendum would generate a great deal of uncertainty, the Scottish referendum last year saw markets focus on the issues at hand only in the two weeks prior to the vote. Market volatility based on an EU vote may not emerge until closer to 2017.
However, one might expect to see some business leaders cite the prospect of the UK holding an in/out referendum as a reason to delay decisions on future investment in the UK. As a result we may start to see the effects first in our local economies and investor sentiment may suffer.
Could it be that we are looking in the wrong place for volatility? A number of commentators have predicted volatility following the election being played out in the currency markets. This hypothesis is plausible, but there is no sign of volatility yet; Sterling has been relatively stable against the US$ and euro over the last few months. Might we see a rout on Sterling if we have an uncertain election outcome?
Like most markets, Sterling does not like uncertainty and protracted negotiations following an election with no single party enjoying an absolute majority could leave Sterling vulnerable. I’m not predicting the George Soros style short-selling of Sterling that we saw during the run up to Black Wednesday in September 1992, but the lessons of the UK being forced out of the European Exchange Rate Mechanism are salient.
If, as a result of perceived Sterling weakness, foreign investors pull out of UK gilts, rates could rise. However, the nervousness that causes could lead UK based investors in risk assets to switch back to safer assets.
In all threats opportunities exist. Whoever wins power will have the same, well-worn issues to address; and short term volatility in markets will present opportunities to nimble multi asset investors. Clients should be poised to act upon any rise in gilt yields (even if only short term) and allow their managers freedom to exploit pockets of value that emerge and seek protection against any potential weakness in Sterling as a result of any increase in market volatility.
Amanda Burdge is a partner at Quantum Advisory
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