UK General Election 2015: Uncertainty Persists

Polls show the Conservatives and Labour are still neck and neck. UK’s political stability remains uncertain

 Labour and the Conservatives remain inseparable in the polls, with the two neck and neck on 34% of the vote (based on an average of top polls) as Britain’s election campaign approaches the final stretch. In last week’s trade alert, we touched upon the major risks associated with different political scenarios (click here for a recap). This week, with the situation largely unchanged, we highlight how the upcoming election still holds much uncertainty and risk for UK equity and debt markets.

Caution creeping in
Since reaching record highs in mid-April (15 April 2015), the performance of UK equity markets has stalled in the run-up to the election with the FTSE 100 (-0.2%) and FTSE 250 (-0.6%) losing momentum. This comes off the back of a strong rally in UK equities since the turn of the year, driven primarily by strong earnings of top UK companies. As investor caution creeps in, there is uncertainty as to what direction UK equity and debt markets will take following May 7.
Indeed, taking a look back at the 2010 election, which bears many similarities to the upcoming election, gives us an indication of how markets have reacted to political uncertainty in the past. The sterling for example, usually a strong indicator of investor sentiment towards the UK, has already succumbed to spikes in volatility relative to the dollar, rising from 6.9% to 11.8% year-to-date and surpassing levels seen in last year’s Scottish referendum. In other asset classes (see Chart 1), UK equity markets were rattled at the prospect of the UK’s first hung parliament in a generation, falling by 9% in the 10 days building up to the election, whilst Gilts strengthened. With this election promising more complexity and greater uncertainty than the last, it is very likely that UK equity markets will follow.

Political jostling and weak growth fuel further uncertainty
Both Labour and the Lib Dems have recently ruled out any formal deal with the SNPs in the event a hung parliament is announced. By distancing themselves from the anti-austerity Scottish Nationalists, who had been tipped as potential deal makers in a tight election, Labour and the Lib Dems are highlighting their commitment towards fiscal consolidation. However, with the Conservatives and Labour needing much more than the support of the Lib Dems to form a stable government based on current polls, any serious prospect of a stable coalition government is now looking increasingly unlikely.
To complicate matters further, UK GDP grew just 0.3% in the first quarter of 2015, half the rate of growth in the previous quarter. With Cameron having made the economy a central issue in his election campaign, this is a huge blow to the Conservatives and casts major doubt over their economic credentials.
All of this simply paves the way for more post-election political wrangling, increasing the number of possible outcomes but also diminishing the chances of a stable government being formed.

Use uncertainty to your advantage!
Investors looking to take advantage of the uncertainty can look back at the 2010 election for an idea on how to position themselves (covered in more detail in the previous trade alert). Looking across a 20 day period centered on the 2010 Election Day (10 days before and 10 days after), the FTSE 100 and FTSE 250 both fell by 9% in the 10 days prior to the election. In the week following the election results, investor confidence initially received a boost, with equity markets recovering and gilts weakening. However, sentiment in risk assets soured as talks to iron out the details of the coalition government went underway. As a result, in the 10 days following the election outcome, equities (large and small-cap) shed all their gains and ended even lower than just prior to the announcement of the election outcome.
With this in mind, investors who held a 3X short ETP tracking the FTSE 100 over this 20 day period of uncertainty would have enjoyed a return of 31%. Similarly, investors who held a 3X leveraged (long) ETP tracking long-dated UK Gilts would have seen their investment increase by 14%. So, it is quite clear that in times of uncertainty, it pays to be hedged.

Viktor Nossek – Head of Research – WisdomTree Europe