A view from Strabens Hall
Very few people saw the election result coming. Whilst Theresa May is in the process of trying to form a new UK government despite losing her Commons majority, we give thought to a number of factors.
From an economic point of view, a key concern is that a weak UK government will struggle to pass legislation necessary to maintain the momentum in the economy.
Looking at Brexit negotiations, here it is likely that the election result may well weaken Britain’s negotiating hand and it is possible that Europe could put a bad deal on the table which would be very hard to counter-negotiate given the composition of the newly elected parliament combined with the very close referendum a little over a year ago.
The Bank of England, to some extent, has very few tools available to assist with growth given that quantitative easing is tapering off and there remains very little room for manoeuvre with interest rates. With the economy already slowing and a pickup in inflation, primarily due to the weakness in the sterling already squeezing household incomes, this is a concern. For investors therefore, the questions is whether the result and the subsequent uncertainty will push the UK economy over the edge?
From a political perspective, it would seem that a second Scottish referendum is now unlikely following the weakening of the SNP. This is a positive and removes one aspect of the uncertainty affecting the UK. It is also possible that there could be a much softer Brexit which could provide stability and succour to the economy and markets. The question is: how will this manifest itself?
On the flip side, the door is now open for another referendum and quite possibly another General Election. Looking at Brexit negotiations, here it is likely that the election result may well weaken Britain’s negotiating hand and it is possible that Europe could put a bad deal on the table which would be very hard to counter-negotiate given the composition of the newly elected parliament combined with the very close referendum a little over a year ago.
But what other risks exist out there for investors? Looking just at the Eurozone itself; one key hurdle was the French election which has now passed. Italy however, is a significant, even chronic issue, that has been identified by the IMF as simply too big to fail and too big to bail out. As such, there remains a lot of pressure from the EU on austerity and a significant amount of monetary stimulus is in place which may keep a lid on this issue. Despite this, Italy remains a risk and is one that, should it go the wrong way, would have significantly greater ramifications on the Eurozone economy than Greece.
So what about outlook? One thing that is clear is that markets have become more anesthetised to political upheaval following the EU Referendum, Trump and the last two UK elections. With 70% of FTSE 100 earnings coming from overseas, to a great extent, many sectors are relatively well protected. Diageo, for example, is unlikely to sell less Jack Daniels in the US, just as Glaxo is unlikely to sell less Ventolin to asthma sufferers around the world. It is the more domestically focused sectors however such as real estate, consumer staples, services, utilities, food and retailing which are likely to suffer most. Mid-cap stocks are likely to suffer as well with margins squeezed as input costs rise due to weakening sterling. Nevertheless, as in any market, pockets of value will exist and it is these that we are looking to the managers in our portfolios to exploit. Finally, it must also be remembered that the FTSE 100 still yields in excess of 4% which is a large positive.
To conclude; the election result is not Armageddon but it does mean that we are entering choppier waters. Although growth could be buoyed by infrastructure spending in the UK, it is likely that this spend could be reined in as bond yields rise and the cost of funding these projects escalates. This combined with a Brexit negotiation which is likely to be increasingly difficult, a slowing economy, rising inflation and a Hung-Parliament means that although the Prime Minister remains, she hasn’t got the clear mandate she wanted and we ought not to be complacent.
Alistair Peel, Director, Strabens Hall Limited.