The orthodoxy of recent election campaigns in the UK has dictated that the party that successful controls the centre ground of the political spectrum (hitherto referred to as Mondeo Man), is the party that will go on to win control of parliament. It was certainly the driving force behind Tony Blair’s three election victories, and the subsequent efforts of David Cameron to “detoxify” the Tory brand with its greener and socially liberal policies prior to the last election. However, such has been the impact of the rise of the fringe parties in the UK, that throughout this current election the Conservatives are being dragged to the right by fear of the UKIP impact, whilst Labour must tack to the left in order to keep pace with the more vocal anti-austerity voices of the SNP, Plaid Cymru, and Greens. Strangely, having the middle ground to themselves has done nothing to improve the election prospects of the Lib Dems.
Ordinarily, this should leave the investment environment in the UK post the election as a highly uncertain place. In the early part of this calendar year, virtually every investment manager who had taken to print had the UK election outcome as the biggest single risk to equity markets in 2015. So why, when everyone is aware of these issues, should the UK equity market be bouncing around its all time high levels?
The most obvious answer is that the UK equity market has a lot more riding on it than UK domestic politics. One third of the FTSE100’s revenues come from overseas markets, and as the Eurozone appears to be finally dragging itself out of a sustained recession and the US economy moves forward steadily, so UK equity valuations should reflect that trend. Yet, the reality is that, even with the influence of fringe parties, domestically there is very little to choose between the policies that are likely to be effected by any party that forms part of the next government. All parties recognise the need to bring down the deficit. The only variable is how quickly. The range of outcomes for the NHS is to guarantee funding at current levels in real terms, or increase funding in real terms. The Conservative’s plan to “Tell Sid” about the sale of Lloyds Banking to the public was criticised on the point of getting full value for the tax payer – not on the point of principle of getting it completely off the government’s books. Headline grabbing squabbles over inheritance tax thresholds, zero hours contracts, non dom payments and mansion taxes are possibly important to play to each of the parties core franchises, but are not materially going to change the economic or investment landscape.
What has genuinely been interesting, is the way that all parties are coalescing around the right to own your own home. Questioning how young people today are ever going to get a foothold on the property ladder in the UK is no longer the preserve of the right leaning parties. Increasingly this is played as a universal right equivalent to suffrage and the presumption of innocence. All parties recognise that the UK property market is dysfunctional. With the exception of UKIP (who would prefer to reduce the demand for housing by keeping Johnny Foreigner out), most realise that increasing the supply of new housing is crucial to addressing the structural demand and supply imbalance that we have in this country. To be fair to the existing government, the changes made to the planning system earlier in this parliament are pretty much universally accepted as having improved the supply of land for new housing. But we would genuinely expect the next government to make further reforms to increase the supply of new housing – whether it is building new social or council owned housing stock, recycling capital tied up in social housing by giving tenants the right to buy, or freeing surplus tracts of government owned land for residential development.
The parties are also all agreed that more people should be taken out of the income tax bracket altogether by raising personal allowances – even if they are not agreed on how it should be funded. Irrespective of whether it is fair or not, even cutting taxes at the lower end of the spectrum but funding it fully from the top level of tax payers will benefit the economy given the much higher marginal propensity to consume of those with lower incomes.
So, in truth, one can argue that equity prices should be fairly immune to the outcome of the plebiscite on the 7th May.
Of course, unless one of the parties intent on changing the political fabric of the country holds the balance of power; whether it is UKIP – who want to change the nature of our relationship with Europe, or the SNP – who want to change the nature of our relationship with each other. These create fundamental uncertainties over the future operation of our economic model and necessarily force up the discount rate on future profits and dividends. For various (and unfortunately too long-winded to set out here) reasons, we don’t believe that the SNP or UKIP will hold anywhere near as much sway on 8th May as many thought they might maybe a month or so ago.
So, it is reasonable to take the current investment market conditions at face value. The UK economy is set reasonably fair. The improving labour market is stimulating growth in real incomes, which in itself will increasingly help cut the government deficit, particularly as more people move into higher tax bands. The housing market has been a crucial plank in the recovery, and will be equally crucial in the next phase of growth – but the driver will be the supply of housing rather than unsatisfied demand. With wage rates rising, companies’ focus will return once again to capital investment and technological improvements – putting to bed the question over the country’s capacity for productive growth. Elsewhere, European economies are now a help, rather than a hindrance, and US Dollar profits are translated back into Sterling at much higher rates.
Yes, equities are much more expensive relative to earnings than they have been for many, many years – but that is natural if one expects better global macroeconomic conditions to deliver better earnings growth. The “value” investor is just going to have to roll with it for a while.
Yes, there are risks and concerns. A Greek default is coming, and we think the impact will be contained, but we can’t be certain. And globally, governments will continue to tighten fiscally for the foreseeable future. But taken together, the investment environment surrounding this General Election is possibly as orthodox as it could be given the circumstances. Which is more than can be said for the General Election itself.