Twelve months ago the prospect of a Labour government seemed implausible. Fast forward to today and there is a real possibility Labour could be in power in months, as the Conservative party becomes mired in a series of self-inflicted crises.
If that does happen there will probably be a seismic shift in the direction of fiscal policy and, possibly, dramatic changes to inflation and the value of sterling. Indeed shadow chancellor John McDonnell told the Labour party conference in September he was preparing for a possible run on the pound if the party wins an upcoming election.
Evidence fund managers are seriously pondering a Labour government was demonstrated by investment bank Morgan Stanley, which last week warned of the party's policies on UK listed companies.
‘We believe that the domestic political situation is at least as significant as Brexit, given the fragile state of the current government and the perceived risks of an incoming Labour administration that could potentially embark on a radical change in policy direction
In response Corbyn released a video saying Labour was a 'threat' to Morgan Stanley and a system 'rigged for the few'.
‘If Corbyn did get in, there is unpredictability as to what might happen to gilts,’ said Will McIntosh-Whyte, assistant multi-asset fund manager at Rathbones.
‘McDonnell has already flagged, if he were to get in, we are likely to see sterling sell off and we tend to agree with him.’
McIntosh-Whyte said a rise in inflation, driven by increased import costs, could lead to further interest rate rises, with a knock-on effect on gilt prices. ‘Any sterling weakness, whether due to a Labour government or Brexit, will lead to imported inflation. Sterling would have to fall a long way to force the Bank of England’s hand, but if inflation rose to 4% then I think gilts would be a fairly unattractive asset.’
One of Labour’s key promises is nationalisation of certain industries, such as railways, energy firms and the postal industry. This would probably have a dramatic effect on some stock prices, according to Citywire AA-rated manager Toby Nangle, multi-asset fund manager at Columbia Threadneedle.
Nangle said certain stocks that could be in line for nationalisation may be vulnerable, depending on the price paid for them by a Labour government. ‘Nationalisation without fair investor compensation would be negative for investors holding these stocks,’ he said.
He added a Labour government would lead to a ‘much steeper yield curve and long-dated yields would rise in anticipation of more inflation’. However he stressed he was not allocating assets on this basis at the moment.
Notes from a small island
John Husselbee, head of multi-asset at Liontrust, said UK political uncertainty, particularly around Brexit, may currently be high on investors’ minds. But it paled into insignificance compared with other external factors, he said.
‘Our market concerns are still driven by the three Cs: central bank policy; China and whether it is slowing down; and commodities and whether the oil price is going up or down, which will dictate inflation across the global economy. Those three things are the biggest factors in the markets going ahead. We live in a global economy and the UK represents no more than 10% of the world’s stocks.’
Husselbee said it was important to have enough global diversification to ensure an event such as a Labour election victory and corresponding fall in sterling would not be overly significant. He added this currency change would also happen before the actual election event.
‘If the markets feared [Labour coming into power], it would get priced into sterling very quickly. But whether there will be a Labour government or not is pure speculation.’