Head of research, Sevier, says political tides are turning. But in which direction?
'Who’d have thought it? Macron’s En Marche party recently swept the board in the second round of the French election. It’s easy to forget that it was only 14 months ago that the En Marche party was formed and it is quite remarkable that they have come from nowhere to secure a resounding victory and banish the two main parties.
Meanwhile in the UK, we have largely returned to two mainstream parties but with the Conservative Party having thrown away a 20% lead. The election result has produced massive uncertainty. For now, PM Theresa May stumbles on but the tragic fire in Grenfell Tower has created further resentment and anger. When Jeremy Corbyn suggested that empty private houses in the region of Grenfell Tower be requisitioned to house the homeless, a YouGov poll suggested that 59% of the population agreed with the idea.
It sounds as if the political tide is turning. Those on the left of the political spectrum have become emboldened in recent weeks with anti-government marches and protests planned as well as demands for a summer of unrest to remove Theresa May.
Perhaps in years to come, ‘Brexit’ and ‘Trump’ in the USA, will be seen as an inflexion point across the world where governments had to spend more to appease the less well-off members of society or risk being voted out. Europe is not immune from this but the pick-up in economic activity has reduced the risk.
In the UK, with the Labour Party being closer to power than anyone thought, investors have once again to consider increased political risk. In particular the chances of nationalisation, higher tax rates, windfall taxes and the minimum wage, as well as Brexit. However, a result of the government’s weak position has been a Queen’s Speech almost entirely devoted to Brexit, with the majority of the contentious manifesto policies removed. For Theresa May the start of the summer parliamentary recess can’t come soon enough!
Actually, we are more hopeful of the UK economy as a result of the general election outcome. There is a risk of a short-term impact, however, ongoing uncertainty has seen business momentum slow over the past 12 months. The most notable impact has been on sterling, which unsurprisingly, weakened on the news. With conflicting messages coming from government and the Bank of England over recent days, in terms of the approach to Brexit negotiations and interest rate expectations, it is understandable why the pound remains around $1.27, a key measure of global confidence in the UK.
Yet, with the majority of UK stock market earnings coming from abroad, the fall in the currency has typically proven a welcome development for those companies.
UK factory orders reached the highest level for 30 years, while export orders climbed to a 22-year high. More domestically focused businesses have undergone a sharp de-rating over the past 12 months. A deteriorating economic environment, including weakening wage growth, alongside rising inflation, has squeezed the UK consumer’s real income. Valuations aren’t expensive, but we continue to monitor potential investment opportunities. Uncertainty could lead to short-term volatility and potentially further disappointment.
June marked the one-year anniversary of the EU referendum and consequently the inflationary impact of sterling’s fall starts to lessen. With the upward pricing pressure of commodities also much diminished, this would imply a better backdrop for bonds. It also remains very difficult to find attractions to such low yields. Particularly bearing in mind the prospect of expansionary policies, alongside the current position of major central banks, which are typically tightening monetary policy.
In spite of the prospect of more expansionary policies, UK gilts have remained largely unchanged. There is an increasing risk that the UK political situation could cause overseas investors to lose more faith in sterling. With 10-year gilt yields around 1%, there is little margin for error and they could be vulnerable to a credit rating agency downgrade. Additionally, if the market were to sense a more aggressive stance to expansionary stimulus, resulting in the government further increasing its gilt issuance, the rebound in yields could be marked.
From a global perspective, economic indicators remain broadly positive, with earnings upgrades, particularly from Europe. While global monetary policy continues to tighten, generally cautious investor positioning should mean equity markets are broadly supported at these levels.'