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Payden & Rygel - A May election in June: What are investors to make of this?

Wednesday, April 19, 2017

Payden & Rygel - A May election in June: What are investors to make of this?

THE ANNOUNCEMENT AND ITS RATIONALE

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It’s worth noting that since the 2011 Fixed Term Parliament Act, the sitting Government of the UK cannot just call an early election; it has to be voted for by two thirds of sitting Members of Parliament (“MPs”), or it must result from a vote of no-confidence. The vote for the two thirds majority will take place today. Despite the ruling Conservatives having only a razor thin 0.8% majority of seats, its passage seems a formality. Most of the opposition Labour Party’s MPs will vote in favour; some because their Leader Jeremy Corbyn has welcomed the opportunity “to go to the people”, but maybe most because he is not well-supported by Labour MPs who have struggled to find a way to dispense with his services. A decisive election loss (likely) would seem certain to do the trick. Opposition MPs voting in favour of an election that they are very likely to lose. Bizarre times indeed!

 Mrs May identifies a strengthened position in Brexit negotiations as the key reason for calling the election. We rather suspect it may also have something to do with opinion polls showing the Conservatives lead over Labour to be the widest it’s been for at least nine years (see the Chart below):

A GLOBAL CONTEXT - THE UK IS NOT AN ISLAND (POLITICALLY ANYWAY)

Harold Wilson, a former UK Prime Minister noted that “A week is a long time in politics.” Rarely can this observation have been more applicable than now. Only a few weeks ago, the UK Government was affirming that an early election was not on the cards.

But of course, it’s not only in the UK that political/ geo-political uncertainty abounds- French Presidential Elections, superpower posturing over North Korea, a seemingly intractable situation in Syria, a disputed Turkish Constitutional Referendum outcome….. and that’s just in the last few days. So, in this context, the May announcement in the UK is part of a pattern of globally unpredictable political developments, that to some extent financial markets have become rather acclimatised to. Not only are these political happenings extremely difficult to foresee, we also have recent examples of seemingly “risky-market-harmful” outcomes actually being not so bad for those markets after all. Look no further than the Brexit vote and the Trump election victory. In both cases, the anticipation of the event was far worse than the reaction to it.

 In our view, the soothing balm of (very) low interest rates is the key reason for the calmness of market reactions to these turbulent political developments. Whilst the US Federal Reserve is raising rates, it is doing so only very slowly, and no other major Central Bank is following their lead. Whilst we cannot assume that this will calm markets in all circumstances, we do think that as long as inflation around the world remains subdued (that’s certainly been the case so far), monetary policy will remain very easy in an effort to bolster generally anaemic global growth.

WHAT DO WE THINK WILL HAPPEN, AND HOW ARE WE REACTING IN PORTFOLIOS?

Most importantly, we won’t assume that we know for sure the outcome of this General Election- there are 7 of those uncertain weeks to go between now and election day. But we will be bold enough to say that a significantly enhanced Conservative majority seems very likely. As does a change of Labour leadership post-election, likely to a more electable alternative. So, a more powerful position for Theresa May as she embarks on Brexit negotiations and deals with demands for a second Scottish Referendum seem very likely outcomes. And even a more credible Opposition Party can be viewed positively from the perspective of the effectiveness of the governance of the country through these important negotiations.

 So, although one could make the case for an emboldened Theresa May pursuing a “harder” Brexit than would otherwise have been the case (and hard Brexit has typically been associated with weaker UK equity markets and a weaker Sterling exchange rate), we favour the idea that stronger rather than weaker leadership for the UK is beneficial to “UK Inc.” As a result, in portfolios which allow active currency management, we yesterday morning closed our long-standing short Sterling currency position versus the US Dollar. And that is our only portfolio reaction for now. Otherwise we look set for more of the same- the UK Base Rate at rock bottom for the foreseeable future, and that helping to support very low Gilt yields, tight corporate bond spreads versus Gilts and historically high equity valuations.

Although risks around eventual Brexit negotiations and geopolitics remain, only a significant upturn in global inflation rates and interest rates looks really threatening for UK market valuations- and that does not seem very likely at all.

 

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