Well, who’d have thought it? Two Conservative Prime Ministers take separate gambles within a year of each other on the electorate solving an apparent problem with Europe and both lose. From holding a modest, but manageable, majority, Premier Theresa May finds herself running a minority government with the Brexit negotiations imminent. The parliamentary Conservative party is doubtless seething, given that she had no real need to go to the country. But what’s done is done. The real issue is what this all means for the negotiations, the economy and markets.
What about the markets?
Markets do not like uncertainty – and a hung Parliament creates just about as much uncertainty as anything can. Yet the initial reaction was for the FTSE 100 Share Index to rise. This is less surprising than you might think. The same thing happened in the wake of the EU referendum. As with the General Election, the result was not expected, so traders immediately dumped the pound. The same thing happened after the June election, but because the Footsie 100 is heavily overseas biased, shares benefited as a result.
Not so the second tier 250 Share Index. This is much more domestically focussed in terms of constituent companies, so it took a hit after the election result. These are businesses where the uncertainty created by this political upset is a real issue. A clear majority for Mrs May would have meant that the outcome of the Brexit talks with Europe, while not wholly certain so far as the final terms are concerned, would at least have stood a very good chance of being ratified by Parliament. A vote on the terms is no longer predictable.
Uncertainty is not good for business
This has major potential consequences for our domestic businesses. Investment plans could well be put on hold, pending a clearer picture emerging from Westminster. In turn this could well impact our economic performance and might even encourage overseas investors to defer decisions involving investment in the UK. This particular gamble looks like affecting both the nature and progress of the negotiations to extract ourselves from the European Union and the very wellbeing of our economy.
Already there is talk of a second General Election taking place, perhaps before the end of this year. Aside from the fact that the population at large is certainly feeling disenchanted with having to go to the polls so often (four times in just over two years if you add in the referendum and last May’s local authority elections), There is no guarantee that such a move would make the situation any easier.
What does history tell us?
I am old enough to remember the two elections of 1974. Again, the first one was called by a Conservative Prime Minister taking a gamble. Again, he lost.
In 1974 we had a miners’ strike, electricity shortages and a three day working week. Edward Heath called the election on the basis of who governed Britain. It turned out not to be him. From having a slim but workable majority, his party was overtaken by Labour which gained 301 seats to his 297, despite having a lower percentage of the popular vote. Even then he might have survived, had the Ulster Unionists not declined to accept the Tory whip in protest to the Sunningdale Agreement of the previous December which aimed to bring power sharing to Northern Ireland. In the event this agreement collapsed later that year.
The second election some eight months later saw Harold Wilson consolidate his grip on power, with the Conservatives losing twenty seats and Labour gaining eighteen. As for markets, UK shares collapsed during 1974, with the bear market that had commenced in the wake of the Yom Kippur war and the quadrupling of the oil price the previous year gaining momentum. It was the worst bear market in my lifetime, with the FT Industrial Ordinary Index of 30 leading British companies (the Footsie had yet to be invented) shedding 70% of its value, peak to trough.
Of course, markets recovered swiftly in 1975, though that was the time when inflation went through the roof and yields on government bonds approached 20%. And circumstances were very different then. The global village had yet to come into being and we still had foreign exchange controls, making investing abroad extremely difficult and expensive. Today the world is our oyster when it comes to investing, but if anything this increases the need to analyse just what might transpire as a result of Brexit and translate that into investment action.
Hold on to your hats
So, what might these negotiations have in store for investors? Of one thing we can be certain – the next two years are likely to be fraught. While this might have little implications for our leading multi-national companies, those operating largely within the domestic environment could find the going much tougher. Exporters may benefit from a weaker pound, but the 250 index seems set to underperform 100 Share Index. UK Smaller Company funds will find conditions more testing and if there is a second general election, the situation could get even worse. I believe this is a time for extreme caution.
