Election result offers fresh questions as well as answers

According to T.S. Eliot’s multi-layered poem The Waste Land April is the cruellest month, but if you are Ed Miliband, Nick Clegg or Nigel Farage then May is already proving to be no fun at all. Rough winds have given all three a vigorous shaking and potentially left their careers with all too short a date, from their perspective at least, if not that of the broad electorate.

The Conservative election victory caught pollsters on the hop, if not necessarily punters, as Betfair saw a late plunge on David Cameron to emerge as the Prime Minister subsequent to the ballot. The equity market seemed pleased, as the FTSE 100 popped over 2% higher on 8 May, while currency traders gave sterling a bid for good measure.

Investors now need to assess the long-term implications for markets and it may therefore be worth revisiting a column released here just over a year ago. This analysis looked at how the UK equity market had performed under the nine Prime Ministers to have held office after the 13 General Elections which have taken place since the inception of the FTSE All-Share index in 1962. AJ Bell’s research has now extended this work to consider at how the bond and currency markets have done, too, while back on the equity stage, certain sectors could conceivably come in for a reassessment, in light of Labour’s political eclipse.

In sum:

• The data since 1962 show that the UK equity market tends to perform best under a Conservative Prime Minister, while the size of a Government’s majority appears to wield little influence.
• The data since 1962 show that sterling is largely unimpressed by whoever is in office or the size of their majority,
• Data on the UK 10-year Gilt total return index since 1983 show the bond market also tends to prefer a Conservative Prime Minister, delivering its best (nominal, pre-inflation) returns during these periods. Again, the size of a majority in Westminster appears to be of little or no concern.

By sector, the market is already offering a guide as to which areas may be reappraised. Utilities, banks, tobacco, transport groups and bookmakers had all faced the prospect of greater regulatory scrutiny, tax increases or both under a Government led by Ed Miliband, according to Labour’s manifesto. Defence spending cuts, targeting Trident and the UK’s nuclear programme, had also formed part of the Opposition’s plan.

A lot of these sectors are characterised by markets where there are a few well-established players and whose demand profile is relatively defensive and indifferent to broader economic trends. They tend to be highly profitable and cash generative, despite the industry-specific challenges they face, pay out generous dividends and tend to be the focus of many UK Equity Income funds. Investors may therefore like to take a fresh look at the leading collectives in this area and quickly sift through their top-ten holdings lists, be they OIECs, Investment Trusts or Exchange-Traded Funds (although according to Morningstar there are only two dedicated UK Equity Income ETFs, and one of those lacks a five-year record, so the table below just looks at passive funds which specialise in UK large-cap stocks).

The best performing UK Equity Income OEICs over the last five years

Source: Morningstar, AJ Bell Research

The best performing UK Equity Income Investment Trusts over the last five years

Source: Morningstar, AJ Bell Research

Headline should be Best Performing UK Large-Cap Blended Equity Exchange-Traded Funds over the last five years

Source: Morningstar, AJ Bell Research

Ballot box blitz

The UK stock market does seem to perform better under a Conservative Government, for whatever reason that may be. The graphic below shows how four of the best five market performances by Prime Minister come under the Tories and the four worst ones all under Labour premiers, dating back to the 1964 election won by Labour’s Harold Wilson, just two years after the inception of the FTSE All-Share index.

UK equities look to perform best under Conservative administrations

Source: Thomson Reuters Datastream, AJ Bell Research.

The experiences of the last 51 years also suggest equity investors are not unduly worried about the size of a Government’s Parliamentary majority. The next chart shows the FTSE All-Share’s performance  against the size of Government majority and there is little correlation between the two – small majorities have been the market do well (and badly) and large ones the same.

UK equities seem surprisingly unconcerned by the size of a Government’s majority

Source: Thomson Reuters Datastream, AJ Bell Research.

The bond market appears to show similar trends. It also seems to prefer a Tory leader and it is also relatively unconcerned about a small majority, at least if historic data from the total return index for the UK ten-year Gilt is any guide.

This chart shows the returns under every Prime Minister since 1983, using the UK 10-year Gilt total return index as the benchmark on this occasion. Note the returns here are in nominal, pre-inflation terms rather than real ones.

UK bond market looks to offer its best returns under Conservative administrations

Source: Thomson Reuters Datastream, AJ Bell Research.

UK bond market also seems unconcerned by the size of a Government’s majority

Source: Thomson Reuters Datastream, AJ Bell Research.

As for sterling, there’s no correlation to note at all between the party allegiance of the PM or the size of his or her majority. The only real trend to note since the 1964 ballot is the long-term decline in sterling when it is benchmarked against the dollar, a currency which has itself hardly been a winner, relative to say the Swiss franc or Europe’s benchmark counter (the Deutschmark and then the Euro)

The long-term trend in sterling against the dollar looks to be down, regardless of who is in charge

Source: Thomson Reuters Datastream, AJ Bell Research.

Clouds remain

Sterling could be a useful indicator for investors to follow, as the incoming Conservative Government still has many issues to address. Four factors suggest it would be unwise to expect everything is going to be sweetness and light for the next five years, from a market perspective.

First, securities prices and currency movements are not just driven by political considerations. Far from it. The performance of equities and bonds is ultimately driven by corporate profits and cash flow, which are themselves shaped in the short term by macroeconomics and in the long term by industry dynamics, a company’s competitive position and boardroom acumen. Government policy and regulation can have a role to play here but it is not the only factor at work, as a company’s customers and competitors can be just as influential.

Second, Mr Cameron’s promise to his Eurosceptic backbenchers of a referendum on EU membership in 2017 still lurks in the background. This is unlikely to go away and is a potential source of uncertainty for the market, since Europe is the UK’s largest trading partner. Whether this weighs on the FTSE 100 and leads clients to further investigate the FTSE 250, owing to the perception it has a more domestic slant, remains to be seen.

The FTSE 250 has handsomely outperformed the FTSE 100 during this bull run

Source: Thomson Reuters Datastream

Third, the UK’s current account deficit remains a concern, as flagged by Keith Wade, chief economist of fund management giant Schroders and Albert Edwards, equity market strategist at French investment bank Société Générale. Britain has yet to rebalance its economy away from consumption and toward manufacturing and exports, while recent increases in credit card use also raise a question mark. In his ever-informative biweekly comment The Solid Ground Russell Napier points out that then Prime Minister Harold Wilson was forced to devalue the pound in 1967 because the UK was running a current account deficit of 0.3%. That pales compared to the 5.6% deficit racked up in the fourth quarter of 2014 so bulls should not be too complacent (although it is worth bearing in mind Mr Wilson was in charge when there were capital controls and currency markets did not function as they do now).

Finally, some of these issues which pertain directly to equity market sectors are not entirely clear cut.

Only tobacco of the more “political” sectors has managed to outperform over the past year, while utilities and banks have lagged

Source: Thomson Reuters Datastream

The Tories are still looking at plain packaging for tobacco and a further levy on cigarettes, while the Scottish National Party’s huge influence in Parliament means the nuclear issue is one where leader Nicola Sturgeon will be looking to make her presence felt. Nor will the banks be entirely off the hook, since Chancellor of the Exchequer George Osborne himself hiked the bank levy in March’s Budget, while Prime Minister Cameron also targeted rail fares during the election campaign. Nevertheless, all of these sectors may feel happier with the devil they know and they could try to regain some of the ground lost over the past 12 months as the election drew nearer.

Russ Mould
AJ Bell Investment Director