UK Election Outlook: Exit from the Impasse?
By Elliot Hentov, Ph.D, Head of Policy Research, State Street Global Advisors
Should we all expect a stonking Conservative majority on the morning of 13 December? The most successful poll of the 2017 election was the YouGov MRP poll, which currently predicts a 68-strong Tory majority. Our own internal analysis adjusts for local dynamics and is more cautious, but still yields a 48-strong majority. Before drawing investment conclusions based on these expectations, it is worth examining where polls could go wrong on election day
There are two ways that existing polls could be right and yet still deliver a surprise. First, if expected turnout is wrong. Notably, turnout expectations were flawed heading into the 2016 referendum, as they did not project traditional non-voters to participate in large numbers, who then overwhelmingly voted to leave. In 2019, the same dynamic could only occur if historic turnout rates among certain demographics perform differently. Figure 1 illustrates how above-average turnout among younger age groups or below-average turnout among older age groups could deliver a different outcome from the polls.
Figure 1: Voting Intention by Age Bracket in 2019
Source: YouGov. Residual % is not displayed and distributed among smaller parties.
The other possibility for a surprise would require geographical divergence and tactical voting in an unprecedented amount. While not impossible, tactical voting historically is only effective when parties cooperate with each other. The hostility between Labour and other remain-oriented parties today makes this outcome even more remote.
Market Perspective
The high conviction around a Tory majority has created a strong market consensus anticipating future government policies. As a start, Boris Johnson is expected to easily pass his withdrawal deal in Parliament and engineer a smooth legal departure from the European Union by 31 January 2020. This near-term clarity could help provide some tailwind to sterling, which has already breached the 1.30 mark versus the US dollar. Drawing on our research of emerging market currencies, we find that markets enjoy another limited bounce upon an election result, even if widely expected. Hence, we would expect political clarity to support up to another 2% appreciation by the new year.
Given that UK equity markets are majority foreign-owned, they have also rallied ahead of the election. Here too, we believe a consensus outcome should not lead to any reversal as the short-term macro backdrop will likely be favourable to equities (and other risk assets).
First, there will be some measure of fiscal expansion. Second, some of the Brexit uncertainty premium would potentially dissolve and should help unlock at least a portion of investment sitting idle. Figure 2 shows just how severely business investment ground to a halt after the 2016 referendum. While it will certainly not catch up to the pre-referendum trend, investment growth should definitely turn positive in 2020, especially for domestic-oriented companies.
And third, global macro forces should help support external demand as central banks around the world inject liquidity and key trading partners (e.g. Germany) recover from their 2019 lows. In our view, a stable, if not slightly appreciating, exchange rate should also enable the Bank of England to keep rates unchanged for the first half of 2020, all in all providing a supportive environment for UK stocks.
Figure 2: UK Business Investment 2010-2019 (rebased at July 2010=100)
Source: Office for National Statistics (ONS).
Nevertheless, Brexit clouds will certainly gather again on the horizon. The lack of clarity over long-term trading relationships is likely to stem the positive momentum a few months into the new year. While we expect an extension of the transition period beyond 2020, a disruptive move towards a bare-bones free trade deal by year-end 2020 remains a possibility. In short, UK political risk will not end after the elections.