Could the election hit your portfolio?

Charles Stanley

Theresa May is likely to increase her majority in today’s general election, although some outlier polls have suggested a hung parliament is a possibility. Here’s what could happen to markets.

Charles Stanley is neutral regarding the outcome of the today’s campaign, but the polling and the commentary about the vote suggests a Conservative win with an enlarged majority.

Politically, this is likely to ensure that there will be no further calls for a second referendum on both Scottish independence and “Brexit” but it is not likely to result in a substantial impact on markets, as the result is essentially priced in. This outcome is also likely to please the City as the general view in the square mile on the UK’s withdrawal for the European Union is that it will happen and it needs to be resolved as quickly as possible.

A solid Tory win could provide some relief for sterling. Indeed the pound rallied overnight to a two week high as markets expect a Tory win. A resurgent pound could result in some weakness in the international behemoths that make up the FTSE 100 – but there are some alternative views. JP Morgan, for example, has argued that a hung parliament could prove good news for the pound if it leads to the prospect of a centre-left coalition that pursues a “softer” Brexit.

However, the consensus view in the City is that a hung parliament would be negative for sterling, particularly against the euro, as it would complicate talks over “Brexit”. The foreign exchange markets are likely to react unfavourably to some of Mr Corbyn’s more radical policies such as nationalisation in certain sectors and a significant fiscal expansion. It is also possible that a slim majority for Mrs May could imply a future leadership contest and more uncertainty, particularly over Brexit negotiations. UK shares are likely to fall in this scenario, but this could prove to be a good buying opportunity as seen in the wake of the referendum to leave the EU last year.

A Bloomberg poll of analysts suggested the pound could fall to as low as $1.20 against the US dollar, should there be a hung parliament. Such a move would be likely to lift the FTSE 100, because of the positive currency effects seen in multinationals who earn a substantial amount in other currencies.

If the Conservative Party fails to secure a majority and we have a hung parliament, there could be a notable impact on markets. The most likely alternative to a Conservative majority government is a left-of-centre coalition including the SNP, Greens and Lib Dems under the leadership of the Labour leader Jeremy Corbyn. This means the Labour Manifesto would be the most important guide to what such a government would do.

Labour party leader Mr Corbyn has pledged to fully nationalise the railways, the water industry, energy companies, and Royal Mail.  His manifesto outlines plans to commit more funding for the NHS, in part through increasing income tax for the highest 5% of earners and by increasing tax on private medical insurance. Labour’s plans for more progressive taxation include a 45p marginal rate of income tax on those earning more than £80,000 a year and a 50% top rate of Income Tax on earnings above £123,000, and a tougher inheritance tax regime.

Mr Corbyn proposes stronger employment rights, more rights for Trade Unions to recruit and influence events, curbs on energy company prices and the “progressive restoration of free education for all”. He would end aggressive military interventions and base foreign policy on conflict resolution. He wants more renewable power with community-owned facilities.

The emergence of Prime Minster Corbyn is likely to be met with higher gilt yields, which will be reflecting of a reduced commitment on deficit reduction. Here’s a brief assessment ion the potential impact on market sectors.

Banks

Banks need a strong economy where borrowing is in demand and profitability is heavily dependent on the level of interest rates. A large Conservative victory could strengthen the UK’s negotiating positions and may lead to a stronger economy which would likely be considered advantageous for the sector. The beneficiaries would likely be those banks with large UK retail exposure such as Lloyds and Virgin Money. A victory by a left wing coalition is likely to be unfavourable for economic confidence and growth which would be negative for the UK domestic banks. It could also lead to higher tax rates, which is likely to be negative for all banks.

Construction

The Conservative approach to construction was set out in the Autumn Statement and would be expected to remain relatively unchanged. So far this has had a minimal impact on construction companies, other than in relation to the three major projects of HS2, Hinckley and the Heathrow expansion. We expect that the Conservative program will gain traction in due course, and also that continuing pressure on local government finances will continue to encourage outsourcing to companies like Kier. A Labour/coalition government would be expected to implement all of the Conservative spending plans, and more. Ashtead could benefit from increased spending on infrastructure. There might be less austerity imposed on local authorities, and overall we would expect sector revenues and profits, and share prices, to respond positively. The only concern might be if wage-driven inflation rose significantly.

Defence

Both the Conservative and Labour Parties have hinted at a desire to nudge up military spending, but the extent to which this would translate into layout for new equipment is unclear. However, the election of pacifist anti-Trident is likely to be negative to defence groups in the short term, despite the Labour Party itself backing Trident. However, the current backdrop of a healthier outlook for global defence spending and heightened geopolitical tensions remain supportive for defence-oriented stocks such as BAE Systems, Babcock, GKN and Ashtead whoever wins.

Energy/Industrials

Labour is targeting 65% of electricity from renewable sources by 2030. This would be a benefit for group such as Johnson Matthey, which manufactures catalytic converters and is developing in new battery technologies. Also, GKN sees a sizeable portion of its revenue being derived from electrification by 2020. Reducing the use of fossil fuels could be a negative for some energy companies especially gas suppliers, as oil is not used as a power source in the UK. However, it would be negative of North Sea oil producers such as EnQuest. Mr Corbyn has also previously stated that he would place a ban on fracking in the UK, which would undermine companies such as Cuadrilla.

Fixed/Mobile Telecoms

The Conservative plan for telecoms, and specifically the build out of fibre broadband, is already advanced with existing commitments to funding and Ofcom pressuring BT via Openreach. A Labour or Labour-led government might impose a full demerger of Openreach, but might do little more in terms of fibre rollout. We would see a full demerger of Openreach as negative for the BT share price. Labour might also attack Vodafone’s low level of UK taxes and a Labour-led government might be hostile to industry consolidation, which would harm the shares of bid targets in the sector such as TalkTalk.

Healthcare

A push to take NHS services in-house under Prime Minster Corbyn could be detrimental to certain companies, including Spire Healthcare which derives around 30% of its revenue from the provision of services to the NHS and to companies such as Saga should there be a decline in demand for private medical insurance.

Housebuilders

A Labour government, or a coalition led by Labour, may commit to build one million new homes over five years, with half of these being Council housing. This might favour the specialists in Mixed Tenure, such as Galliford Try and Kier Group. Affordable housing has lower margins for housebuilders. If councils were instructed to impose a higher proportion of affordable housing (e.g. 50%) on every planning application, this would have the effect of an immediate reduction in the value of housebuilders’ land banks and therefore negative for the sector.

Media

The current Conservative Government appears to prefer a relatively light touch approach to regulation of the UK media. A Labour or coalition government would probably adopt a more heavy handed approach. In particular, the Labour Party could look to block the proposed takeover of Sky by 21st Century Fox. We see downside potential of 20-25% in the Sky share price if the deal is blocked or abandoned. One pollster, YouGov, issued what could be an outlier poll at the end of May suggesting that a hung parliament was a possibility. The seats prediction used a new methodology, leading to many commentators to claim the position was “brave”. However, should the pollster prove correct and no overall majority is the correct position, its shares could benefit from the outcome.

Retail & Leisure

The Labour Party’s proposals to increase the marginal rate of income tax for higher earners could act as a brake on consumer spending. We would expect any impact, however, to be limited to higher end retailers and sellers of large ticket items such as luxury goods and car distributors. The better off also have a higher propensity to save, so may simply choose to save less and spend more of their disposable income following any increase in tax rate. The Labour party’s proposal to raise the National Minimum Wage to £10 per hour could potentially create an additional cost headwind to companies in the retail and leisure sectors (e.g. pub companies and hotel operators) which employ large numbers of less skilled workers.

Support Services

Private contractors such as Capita, Serco and G4S provide services for both central and local government. Overall, central and local government spends £200bn in the private sector and, for the big contractors such as Serco, Capital and G4S, Labour will be expecting to get a better deal for taxpayers.

Transport

A Labour-led Government could be extremely challenging for most listed transport companies. Labour does not like the privatised train industry and the de-regulated bus market outside London. First Group, Stagecoach and Go-Ahead all own rail franchises which would be under threat from labour plans to re-nationalise rails services. For Airlines, (easyJet, Ryanair and International Consolidated Airlines Group) negotiations over Brexit are extremely important and we assume the current Conservative Government is more advanced in its plans to deal with regulations over EU flying rights. Overall, a Labour-led government is likely to impact most share prices in the transport equity sector.

Utilities

The Big Six energy suppliers, which control over 80% of the market, are currently out of favour with politicians, irrespective of party. Regardless of the outcome of the snap election, there is likely to be further intervention in the market.


The above article  was first published by Charles Stanley on 8th June 2017.