The Conservative government massively underestimated the power of populism. This election turned out not to be about Brexit, but about generational difference in the UK. The Conservatives set the tone early by wanting to means test the winter fuel payment, reduce the triple lock on state pensions to a double lock and to introduce more clarity around social care for the elderly. Pensioners have been the sacred cow no politician wants to slaughter for coming up to two decades now and these reforms were seen as essential to start evening out society. Austerity has hit far harder those of working age compared to pensioners, therefore it was unfortunate to hear Labour defending the winter fuel payment for millionaire pensioners! The Tories’ message started off badly before Labour then pulled out the first of many rabbits from the hat, with the question of costings paramount in economist’s minds. The key one, and the one that seems to have gained most momentum, was abolishing university tuition fees.
So this election wasn’t really about Brexit as everyone thought, but about generational difference in the UK. The problem is, as the noted French economist Frederic Bastiat once said; “Everyone wants to live at the expense of the state. They forget that the state wants to live at the expense of everyone.” At the end of the day, someone has to pay!”
In my view that’s the context, but as investors what are the ramifications of the current situation we are in, namely a hung parliament?
Turning to the economy first, it has been slowing for a while. 2016 confounded many, especially after the Brexit referendum, with the strength of the UK economy. We were one of the fastest growing, if not the fastest growing, major economy in the world. It wasn’t fuelled by exports as many suspected after sterling’s sharp depreciation last June, but by consumer spending and lots of it. Unfortunately, this isn’t sustainable in the long term when most of it was spent on credit. Roll into 2017 and the economy has slowed sharply, not in recession yet, but enough to worry policy makers. Factor in more reluctance of banks to lend and the consumer binge is probably coming to an end. The latest retail sales figures look uninspiring at best. On the positive side (unless you are a cash saver), a weak economy means there is no chance of an interest rate rise in the UK until probably 2019 at the earliest. Another factor that is weighing down the economy is lack of real wage increases. In other words, wage rises that are higher than inflation.
With a weak currency, due to political uncertainty, Sterling hasn’t a huge chance of making a large-scale recovery even though it looks cheap on a global basis. So, weak economy, weak currency, uncertain politics, and Brexit to negotiate from a position of weakness not strength.
Looking at Brexit, it is too early to say how the new government will approach negotiations. There is a school of thought this could mean a softer Brexit, however I’m not convinced as any deal needs to be approved in parliament, which will be problematic, therefore increasing the likelihood of a hard Brexit. Now is not the time to discuss the merits of soft versus hard Brexit, but in my view, it isn’t as clear cut as one bad, the other good.
Sterling weakness isn’t necessarily a bad thing from an investment perspective. Approximately 70% of FTSE 100 earnings come from overseas, meaning a weak pound boosts profits and dividends. Even looking at the FTSE 250, about 42% of earnings are derived overseas. A weak pound also boosts UK based exporters and hikes the value of existing overseas assets. Therefore, today the FTSE 100 has risen and the FTSE 250 had fallen in response to the near 2% fall in Sterling versus most currencies.
The bond markets have reacted relatively calmly, as although there will now be a loosening of austerity, it won’t be the splurge that Labour promised. Gilts barely moved today.
Whilst we might think the election was important today, and it is for many, for investors it isn’t so important. Your portfolio will probably have between 15% and 29% in UK listed shares, with a big proportion in large companies which, as mentioned earlier, earn much of their profit overseas. Therefore, what happens on a global basis has far more importance than here in determining your wealth. You should be more interested in the Asian and US consumers and not fret too much about dear old UK. For what it’s worth, I’m still heavily invested in both UK and overseas investments and won’t be recommending any material changes to SFP’s porfolios as a result of this election.