The UK election takes place this Thursday and, as we have mentioned, UK asset prices have generally been relaxed as we head to the polls. In contrast, opinion polls have given a wide variety of potential results, which makes it hard to predict who will be declared the winner from this election or if the UK will be faced with a hung parliament.
Financial markets have mostly looked through the noise of the opinion polls, the pound has wobbled but not in a serious way and the FTSE 100 reached a fresh record high on Friday. This is partly explained by the odds market, which is predicting a 92% chance of a Conservative majority. While markets feel fairly confident that Theresa May will win on Thursday, any upset from this election could have a major impact on financial markets.
The potential fallout from a Labour win
We believe that a win for Labour, or a Labour-led coalition, would have the biggest negative impact on UK asset prices. In this note we are focusing on the impact on equities, however, we would also expect a short, sharp decline in sterling, as the FX market adjusts to a new political reality.
We think that elements of the Labour manifesto, if implemented, could have a deeply negative impact on some UK stock prices. The details of the manifesto that are concerning for financial markets include:
· The rise in corporation tax – broadly negative for UK asset prices.
· Financial market regulation overhaul including the division of retail and investment banks.
· Preventing banks from cutting costs and shutting down high street branches.
· Nationalising water companies, railways, energy companies and the National Grid (LON:NG).
· Regulating the ownership of the media and increasing regulations for journalism and media output.
While UK equities have continued to perform well in the run-up to this election, the prospect of nationalisation from a Labour government has caused investors to cool on the utilities sector. As you can see below, there has been a synchronisation in the performance of Severn Trent (LON:SVT), United Utilities, Centrica (LON:CNA) and National Grid, and since the last week of May, they have all experienced sharp declines at the same time as Labour started to close the gap with the Conservatives in the opinion polls.
Utilities at risk if Labour wins
If Labour does win, or if it forms a coalition government, then the prospect of nationalisation would be likely to keep downward pressure on these stocks for the medium-term. Interestingly, the National Grid has experienced the sharpest decline, followed by Centrica. Thus, in the event of a shock Labour win we could see larger declines for United Utilities and Severn Trent, as they play catch up.
The banking sector
As you can see, if Labour does win this week then there could be ramifications for the banking sector. The chart below shows how the UK’s major banks have performed. This chart has been normalised to show how these banks move together. This chart clearly shows that HSBC (LON:HSBA) has outperformed the sector, it has even outperformed the entire FTSE 100 index (purple line). This is unsurprising due to its large exposure to overseas earnings. In contrast, Lloyds (LON:LLOY) and RBS (LON:RBS) have been long-term underperformers in the FTSE 100, which is down to multiple factors, but their most recent weakness may have been exacerbated by the narrowing of the opinion polls in the run up to this election.
Barclays (LON:BARC) had been outperforming the FTSE 100, however, its performance started to slip at the start of May, and this may be partly down to the threat to a bank like Barclays from a Labour government. Barclays has a large retail branch network and a thriving investment bank, so it could be high on a Labour government’s target list. Thus, in the event that Labour does win on Thursday, or if we get a Labour-led coalition government, we would expect to see Barclays come under sustained downward pressure along with RBS and Lloyds, and for HSBC to outperform other UK banks.
To conclude, the prospect of a win for Labour, or a Labour-led coalition, is a low probability but high risk event. If this happens then we would expect large declines in the FTSE 100, particularly for the banks and utility companies listed above. However, we would expect a broad recovery in the utilities sector and for Lloyds, RBS and Barclays if the Conservatives can win a majority this week and the Labour manifesto never sees the light of day.
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. Any references to historical price movements or levels is informational based on our analysis and we do not represent or warrant that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, the author does not guarantee its accuracy or completeness, nor does the author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.