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What the general election shock means for stocks

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What the general election shock means for stocks
 

Leading fund managers have warned that the shock general election result leaves a huge cloud over the UK’s equity, bond and currency markets.

They argue that UK assets will be haunted by the spectre of a second general election, potentially held within a year, alongside a second referendum on the UK’s exit from the European Union (EU).

Simon Brazier, manager of the Investec UK Alpha fund, said a second EU referendum could not be discounted. In his opinion, the lack of mandate for the Conservatives increases the chance of a ‘softer Brexit’, which would mean staying in the single market. 

'This will provide some comfort to many and may steady both the currency, bond and equity markets. Negotiating Brexit on a two-year time line was always going to be an uphill task. This election result now makes it even more likely that Brexit negotiations will take longer. The longer it takes, the higher the chance of a second referendum. This should not be discounted,’ he said.

He suggested a second referendum could take place at the end of the period of negotiations if parts of a coalition government were unhappy with the deal that was on the table and would prefer to put it to the electorate.

Prospects for pound 

Investors are divided over the impact this uncertainty over the Brexit negotiations could have on the pound. Sterling has fallen today in response to the shock election result, and Monica Defend, head of global asset allocation at Pioneer Investments, said the currency was likely to remain under pressure.

‘With a weak government and political uncertainty emerging from this election, the path towards a smooth Brexit is less clear,’ she said.

The probability for a hard Brexit is now smaller, but the UK’s negotiation stance has likely been weakened and medium-term growth prospects for the UK could be dampened by the increased uncertainty, with negative implications for sterling.’

But others argued the likely move towards a ‘softer’ Brexit would prove positive for the pound.

It will soon become apparent that expectations for Brexit have become softer, suggesting that the pound can resume its upward progress,’ said Chris Derbyshire, chief investment officer at Seven Investment Management.

The large remain minority proved itself to be a significant voting bloc. Negotiations with the European Union (EU) may have to be delayed, increasing the necessity for a transition deal that should cushion the impact of Brexit on the economy. While this result makes negotiations with the EU more complicated and difficult in the short term, it almost certainly makes the outcome softer.

Schroders’ economist Azad Zangana said that even if Theresa May maintained her push for a ‘harder’ Brexit, the election result would leave her on the back foot with EU negotiators.

I think what will happen is that we will be offered a "take it or leave it" deal - and I don't think the government will have much power to negotiate away from that deal,’ he added.

This is because of the difficulties the government now faces in terms of achieving political consensus.

‘Europe can now ignore what Theresa May wants and pitch something that is a lot softer, knowing that the rest of parliament is more likely to support it,’ he said.

Alix Stewart, a fixed income specialist at Schroders, added there was an irony that Theresa May initially set out her intention to help those ‘just about managing’ and has today been left ‘just about managing to stay in power’.

Back to the polls?

The Conservatives’ failure to gain a majority in the general election creates the potential for another general election, which could be held within a year.

Jim Leaviss, head of retail fixed interest at M&G, believed a Conservative-DUP coalition would find it difficult to govern. He said there was every prospect Labour could use its momentum from yesterday's strong performance to win an autumn election and implement its agenda of nationalisation and increased public spending.

'It was a fantastic Labour result,' he said, pointing out it was the party's biggest increase in the vote since Clement Attlee's post-Second World War landslide in 1945.

It had been achieved by a huge turnout by younger voters, 72% of whom had voted Labour, Leaviss said. 'They all turned up and voted predominantly for [Jeremy] Corbyn.'

David Docherty, a UK equity fund manager at Schroders, suggested the prospect of another election resulting in a Labour majority or a Labour minority government was likely to ‘gnaw away’ at investor sentiment towards UK assets.

This could be particularly detrimental for the gilt market, as a significant number of overseas investors hold UK government bonds.

'Largely the investors who fund borrowing in the UK tend to be overseas. If there is any question of fear for the direction that the UK is going with Brexit – with maybe a Labour government or more political uncertainty or upheaval - we might find that investors prefer to invest in other bonds. We could see the gilt market underperforming and borrowing costs rising in the UK, certainly relative to other countries,’ explained Stewart.

If political uncertainty causes overseas investors to shun UK equities and bonds, this could cause the so-called risk premium (the reward you receive for taking on risk) associated with UK assets to increase.

 
Rising gilt yields could also result in mortgage rates rising, as mortgage rates are priced off gilt yields and real interest rates.

If it started to look likely that Labour was able to form a minority government, or primed to take power in the next poll, Docherty said this would raise the possibility of so-called ‘reflation trade’ emerging in the UK. As Labour’s manifesto included higher government spending, this could ultimately result in inflation. 

What it means for stocks

In spite of the uncertainty, Docherty believes that the sell-off in domestically-focused UK stocks may present investors with selective opportunities.

Although the pressures facing consumer-facing stocks cannot be underestimated, particularly at a time of rising inflation, Docherty suggested the retail sector could offer some value.

'I am currently thinking about some of the stocks in the retail sector as examples. I would probably have a preference for companies that have some kind of internal story, perhaps the way the company is managed or their scope to improve returns,’ he said.

Brazier suggested backing companies that were not reliant on the strength of the UK economy and instead have ‘self-help’ characteristics which mean they can reinvest cash back into the business.

Alternatively he pointed to  recovery stocks, such as Rolls Royce (RR) or Balfour Beatty (BALF), where new management teams were implementing turnarounds.

He suggested steering clear of any companies that could be affected by a changing political backdrop, such as Royal Mail (RMG), house builders, gambling companies and utilities.

'If there is a second election, that provides political risk into those business models,’ Brazier added.

But others were more optimistic about prospects for house builders, which were among the worst hit stocks as markets digested the shock election result.

Richard Buxton, head of UK equities at Old Mutual Global Investors, said the voters’ rejection of austerity policies could support the sector.

‘The most significant impediment to the sector’s continued progress had appeared to be a discontinuation of the Help to Buy scheme, of which there was no mention in the Conservative manifesto,’ he said. ‘As we enter an era of increasing anti-austerity, the scheme’s survival prospects may now improve.’

David Jane, fund manager at Miton, agreed. ‘We have a small holding in the house builders, where recent slower mortgage approvals and the election have caused prices to weaken short term, and the currently low mortgage mortgage rates and wider availability of high loan-to-value offers mean the background for volume remains favourable.’

Richard Colwell, head of UK equities at Threadneedle, was meanwhile sanguine about the broader picture for UK stocks, arguing the initial market reaction could prove short-lived, as it did with the Brexit vote and Donald Trump’s victory in the US presidential election.

‘The UK market has been out of favour with international markets for some time. Asset allocation to UK equities is already as low as it was in 2008 at the height of the banking crisis, so there is no sense of hot money leaving the market,’ he said.

‘So lots of uncertainties and the domestic political and economic path forward is murky. However for UK equities the outlook is more measured and we will be looking for selective buying

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