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We look at equities, funds, gilts, pensions, tax and more following news of a hung parliament
Thursday 15 Jun 2017 Author: Daniel Coatsworth

Investors are closely watching prime minister Theresa May for signs of how she will control a minority government following the UK general election result.

The markets have so far given a fairly tame reaction to the changing political landscape. However, events over the coming days could have great importance to investors, so read this article to understand what the election result means for your money.

What's the next big event?

The key test of any new alliance with the Democratic Unionist Party (DUP) was supposed to happen on 27 June when MPs were due to vote on the government’s legislative programme for the coming year.

That date has now been thrown into doubt after delays to the Queen’s Speech (previously scheduled for 19 June) which is the official unveiling of all the laws the prime minister hopes to get through parliament.

The delays could suggest that some manifesto pledges will be dropped or watered down.

How shocking was the result?

Berenberg’s senior UK economist Kallum Pickering says the Conversatives losing their majority in the House of Commons is ‘not a repeat of the Brexit vote on 23 June’ last year.

He adds: ‘Instead, the political uncertainty coming from the result is partly compensated by the small chance that Brexit may not happen and by the hope that the UK may opt for a less hard Brexit.’

On the subject of referendums, it is worth noting the Scottish Nationalist Party’s loss of several seats to pro-union political parties would suggest there is a reduced likelihood of a second referendum on Scottish independence.

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UK General Election 'is not a global risk event'

Deutsche Bank’s first take is that the result of the UK election is ‘not a global risk event’ and the impact will be confined to the UK.

Unfortunately the UK economic backdrop is not helpful. Jim Leaviss, head of retail fixed interest at M&G Investments, comments: ‘The momentum of UK economic growth has been fading as we move through 2017.

‘Retail sales growth, house prices and inflation adjusted incomes are all weakening in what remains a very consumption driven economy. This election result and the continued uncertainty it brings suggests that this trend continues.’

What is the political situation?

To quote the Russian revolutionary Lenin, ‘there are decades where nothing happens; and there are weeks when decades happen’.

In a fast-moving environment, it is hard to say with certainty May will remain prime minister by the time you read this article.

Swathes of the Conservative party will be uncomfortable with the DUP’s positions on same-sex marriage and abortion. Any combination with the party could undermine the UK’s role as an independent broker in Northern Ireland.

The fragile nature of the partnership raises the possibility of a Conservative leadership battle, another election and another referendum on the UK’s membership of the EU. Such events could provide yet another bout of stock market volatility. (TS)


 

Imitation model green plastic houses with roofs rest on top of British fifty and twenty pound notes

THE OUTLOOK FOR EQUITIES, STERLING & GILTS

News of a hung parliament triggered renewed weakness in sterling and lifted many of the stocks which also jumped following the Brexit vote last June, principally FTSE 100 companies with overseas operations.

These companies benefit from a drop in the pound as it makes their exports more competitive and boosts the value of foreign earnings.

Drinks giant Diageo (DGE), packaging group Smurfit Kappa (SKG) and construction firm CRH (CRH) all saw their shares rise following the election news.

‘With the UK running a sizeable external deficit and on the threshold of renegotiating its trading relations with its largest trading partners, a weak pound seemed on the cards whatever the election result (at least beyond the first few days, had a Conservative landslide created a sugar high),’ says Andrew Bell, chief executive of Witan Investment Trust (WTAN).

Although the pound stabilised on Monday (12 June), its future direction will depend on political clarity and an update on Brexit negotiations which are due to begin next week.

‘Brexit negotiations remain key near term, but with such lack of clarity the outlook for the pound and the gilt curve remains unclear,’ says Charlie Diebel, head of rates at Aviva Investors.

‘The take for gilts is modestly negative as the market will demand a greater risk premium for owning assets with so much political instability attached to them,’ he adds.

The market will demand a greater risk premium for owning assets with so much political instability attached to them

 

What happened to FTSE 250 stocks?

The more domestic-focused FTSE 250 equities index initially fell on the election result, albeit ending the day 0.1% higher.

The mid-cap losers were predominantly ones with exposure to consumers, as they are negatively affected by a weaker pound, and property. They included housebuilder Crest Nicholson (CRST), mortgage lender Virgin Money (VM.) and DIY retailer Travis Perkins (TPK).

Ritu Vohora, equities investment director at M&G Investments, says UK stocks are cheap on both an earnings yield and a historical price to book basis. However, she says companies with predominantly domestic earnings are vulnerable to import price inflation and so stocks with a high UK exposure may struggle near term.

‘The FTSE 100 large-cap index has been strongly driven by currency moves since the UK’s vote to leave the EU,’ says Vohora. ‘However, the FTSE 250 index has underperformed the FTSE 100 by c. 3% in recent weeks, suggesting that investors had started to factor in election risk.

‘The increased uncertainty could hamper prospects for domestically-focused UK stocks, and the FTSE 250, with foreign exchange moves impacting their profit margins and the real disposable income of their customers.’ (DC)


THE OUTLOOK FOR SPECIFIC SECTORS

 REAL ESTATE and HOUSEBUILDERS

Real estate and housebuilding are among the most sensitive sectors to what is happening in the UK. It was therefore no surprise to see some reaction in asset prices in the wake of the election result.

M&G Real Estate’s head of property research Richard Gwilliam argues the dynamics behind UK real estate remain strong thanks to ‘a lack of significant supply of space’.

He notes the attractive yields on offer and adds the ‘renewed cheapness’ of sterling should boost the UK’s attractiveness to foreign investors.

A member of Investec Structured Property Finance team, Hayley Scott, is less relaxed. She suggests projects may be put on hold as banks withdraw financing.

‘Real estate as an asset class will lose favour with institutional and overseas investors as doubts hang over the UK real estate sector,’ she says.

On the housebuilding side, while all the major parties want the UK to build more houses, the uncertainty created by the election may lead to delays in house purchases and other building work, putting some pressure on volumes.

Broker Peel Hunt flags Telford Homes (TEF:AIM) as being better positioned thanks to its bumper order book and exposure to the emerging build to rent space. (TS)

Banks

A softer Brexit could favour UK banks, according to various investment experts. Jefferies analyst Joseph Dickerson says if a so-called ‘hard Brexit’ is dead, then a resulting reassessment of risk could boost shares in UK-centric banks.

Going into the general election, UK banks were trading on an ‘uncertainty’ discount, a remnant from the decision to leave the EU.

Dickerson says the earnings backdrop for UK banks is more favourable than perceived because impairment indicators are stable at worst.

The banks favoured by Dickerson include Lloyds (LLOY), Virgin Money (VM.) and Metro Bank (MTRO), all with ‘buy’ ratings.

Conversely, Ian Gordon, an analyst at Investec Securites, says that Barclays (BARC) is the only large cap UK bank still offering material share price upside on a 12 month view.

He suggests investors should also look at the challenger bank space such as OneSavings Bank (OSB). (DS)

Insurance

‘A hung parliament with the Conservatives the largest party makes a hard Brexit less likely with parliamentary checks and balances leading to broad Brexit package support rather than a rush for the exit,’ says stockbroker Peel Hunt.

‘There is, however, another chance of a general election down the road, so uncertainty remains.’

It adds: ‘The insurance sector has already adapted to a hard Brexit with many Lloyd’s insurers and the Lloyd’s market announcing the creation of local subsidiaries in the EU (4% premiums in EU), hence the uncertainty over whatever Brexit brings has diminished.’

Peel Hunt is positive on Novae (NVA) and Lancashire (LRE) among the Lloyd’s insurers. (DS)

Retailers

Uncertainty and a further slide in sterling arising from a hung parliament are negatives for retailers.

Broker N+1 Singer expects this ‘to exacerbate margin headwinds, add to imported inflation and erosion of spending power, and weigh on confidence amongst many consumers’.

Domestic consumer stocks, especially those reliant on foreign sourcing and an above average age demographic, are in the firing line.

RBC Capital Markets concurs that the election outcome is ‘a negative for UK exposed businesses with high dollar sourcing costs’, highlighting Sports Direct (SPD), B&M European Value Retail (BME), Next (NXT) and Marks & Spencer (MKS) as among those vulnerable.

Conversely, ASOS (ASC:AIM) and Kingfisher (KGF) are ‘relative gainers short term’ given their ‘relatively high non-UK exposure’. (JC)

Gambling firms

Stockbroker Davy views the election result as unhelpful for Ladbrokes Coral (LCL) and William Hill (WMH).

It says ‘gaming sector regulation ranks fairly low down the list of priorities for those parties grappling with government formation and imminent Brexit negotiations’ and ‘the uncertainty that has weighed on the UK retail betting companies is likely to persist for some time to come.’

Specifically, Davy sees an increased risk the next government will make a more severe cut to the gaming machine staking limit than might be mandated by a forthcoming regulatory review. (JC)

Many utility and energy companies had been weak after both major UK parties pledged potential caps on energy bills

 

Utilities

One surprise is the modest rebound in some utility stocks, possibly as a sign of relief that Labour didn’t get a chance to enforce its various threats for parts of the sector.

‘Many utility and energy companies had been weak after both major UK parties pledged potential caps on energy bills,’ points out Colin Morton of the Franklin UK equity team.

‘We view a Conservative/DUP coalition as thematically more favourable, as the threat of Labour introducing more punitive policies has for now receded,’ say analysts at RBC Capital Markets. They flag reduced risk of nationalisation of water companies, in particular. (SF)

Healthcare

There may be limited impact on the healthcare sector despite uncertainty concerning the hung parliament as investors generally focus on developments in the US market when looking at the sector. (LMJ)


 

BREXIT – WILL IT STILL HAPPEN?

Few are seriously suggesting that Brexit won’t happen… but who leads the talks and what type of negotiations is now up in the air.

Whether the general election result was a mass rejection by voters of May’s hard Brexit stance remains open to debate but the large youth vote was a surprise.

‘Early indications suggest a turnout of 72% for 18 to 24 year olds,’ points out Colin Morton of the Franklin UK equity team. ‘All the evidence suggests young people were generally in favour of the UK remaining in the EU.’

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That may give Labour leader Jeremy Corbyn the wiggle room needed to keep protections for existing worker rights and tariff-free access to the EU single market within any deal – should Corbyn find a way to lead the country or a form of cross-party consensus emerges on EU negotiations.

‘We sees bigger risks of an economically disruptive no deal,’ say analysts at the BlackRock Investment Institute, although that appears to be a doomsday scenario at this stage. A softer Brexit is seen as more likely.

‘A Conservative-led government will most likely have to make compromises with other parties,’ says Hetal Mehta, senior European economist at Legal & General Investment Management. That view is shared by Franklin’s Colin Morton. ‘Already the language coming from the Conservatives has been toned town in terms of Brexit.’

Chris Darbyshire, chief investment officer at Seven Investment Management believes ‘a soft, Norway-style Brexit represents the path of least resistance both for the British nation and for our biggest trading partner.’ (SF)


 

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WHAT DOES ELECTION MEAN FOR PENSIONS AND TAX?

The Conservative Party may find it harder to push through some of their proposals on the personal finance front, if they now require the co-operation of the DUP.

For example, the Tories want to switch the triple lock on state pensions to a double lock system. The former guarantees state pensions rise at the highest of average earnings, inflation or 2.5%. A double lock ditches the 2.5% factor.

The DUP manifesto includes a commitment to the triple lock, so that system seems likely to remain in place if the DUP form an alliance with the Conservative Party.

Elsewhere, a question mark still hangs over various items that were originally included in the Conservative’s finance bill, but which were put on hold when the snap election was called. This includes a reduction to the dividend tax allowance from £5,000 to
£2,000. (DC)


 

HOW HAVE FUND AND WEALTH MANAGERS REACTED TO THE ELECTION RESULTS?

Noland Carter, head of Heartwood Investment Management, says within the UK equity market, ‘our bias is towards larger companies, which have performed well over the last year and have benefited from the depreciation of sterling.

‘The scale of the imbalances of the UK economy – large current account and budget deficits – keeps us underweight in both sterling and UK government bonds on a duration basis.’

Ariel Bezalel, manager of Jupiter Strategic Bond (GB00B2RBCS16) remarked that UK bank debt features prominently in his portfolio. ‘These banks are in good shape from a capital perspective, so are not a cause for worry,’ he explains.

‘Overall, the portfolio should not be too impacted by an extended period of political uncertainty.’ Foreign currencies make up around 8% of the portfolio and ‘their appreciation against the weaker pound, should help mitigate any temporary weakness we may see in our bank holdings.’

Benefits of broad exposure

Close Brothers Asset Management’s chief investment officer Nancy Curtin explains that ‘times of uncertainty can create interesting stock specific opportunities as pockets of value often emerge’.

She adds: ‘As multi asset class investors, our portfolios have broad exposure to global companies, many of which can continue to benefit from improved global growth and earnings expectations that have little to do with UK politics.’

Meanwhile Mike Pinggera, manager of the Sanlam Four Multi-Strategy Fund (IE00B8HRMZ88), points out that 25% of his fund is invested in real assets. ‘We are invested for the longer term in the pillars of a functioning economy – education, transport, healthcare, energy and housing.’

More opportunities could soon emerge

Pinggera points out that ‘market moves over the next few weeks may throw up some good long-term opportunities, but to a large extent, this is a domestic issue for the UK’.

He says: ‘We will look to see if there are opportunities to deploy some of our cash. However, while equity volatility remains low, we would rather participate in any future equity upside by owning options, where the downside is clearly controlled. The uncertainties have increased, particularly over the future of Brexit negotiations.’

Market moves over the next few weeks may throw up some good long-term opportunities, but to a large extent, this is a domestic issue for the UK

 

Miton’s David Jane sees some opportunities in the consumer services area, where expectations and valuations are low despite the leading indicators remaining strong.

‘Here we favour the pub and restaurant groups. Similarly, we have a small holding in the housebuilders, where recent slower mortgage approvals and the election have caused prices to weaken short term. The currently low mortgage rates and wider availability of high loan to value offers mean the background for volume remains favourable.’ (JC)

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