“Markets seem braced for a crushing Labour win, and a small majority or even a coalition would perhaps be the unexpected – and least-favoured – outcome from the narrow perspective of investment,” says AJ Bell investment director Russ Mould.
“Taking their lead from the opinion polls, markets have priced in a hefty Labour majority. If this is the outcome, there should be a relatively muted response from the pound, gilt market and stock market on 5 July (and beyond).
“Financial markets usually give their quickest and most visceral judgements on a country’s economic and political stability (or otherwise) via its currency and the rate of interest at which they charge it to borrow through the bond markets.
“Sterling collapsed in the wake of the Brexit vote in 2016, and has never recovered the ground it lost, while the surge in the yield on the benchmark ten-year UK government bond, or gilt, in 2022 told you all you needed to know about what markets (and not just bond vigilantes) thought about the unfunded tax-and-spend promises of Trussonomics.
“The lack of available cash in the government’s kitty, the Conservatives’ occasionally frayed relationship with ‘business’ and the likelihood that Labour took on board Trussonomics’ lesson that unfunded promises could prompt chaos may also mean that investors could be in the mood to take the Sir Keir Starmer-Angela Rayner-Rachel Reeves ticket with equanimity.
Small majority
“A small Labour majority which gives some potential influence to the fringes of the party could be a concern, if it hobbles the government in the way fractious in-fighting has done a series of Conservative administrations since 2010.
“It could also be seen as a concern if the left of party is emboldened, and able, to hold out for more aggressive tax-and-spend policies, or gives unionised labour a chance to make more strident pay demands. From the selfish perspective of markets, these could be seen as inflationary and also potentially damaging to Labour’s promises to borrow and spend in a responsible manner.
“In this case, bond yields could go up (and if they stay there, take mortgage rates and broader borrowing costs with them) to the detriment of the economy and the incoming government’s ability to spend, given the higher interest bill, which is already expected to come to a very uncomfortable £89 billion in 2024-2025, according to the OBR.
“Sterling could get a boost from higher bond yields, as higher returns on bonds tend to attract cash, but a stronger pound would probably upset the FTSE 100, given its overseas earnings, and also crimp exports.
Regulation and sectors under the microscope
“Labour has promised not to increase income tax, VAT, NI or corporation tax. Although it has said nothing on income tax thresholds, for example, this still leaves it with very few levers to pull, barring capital gains tax reform on private equity and a windfall tax on oil and gas.
“Markets will look for future discussions on CGT more widely and also whether any other industries come under the microscope – one of Tony Blair’s first acts was a windfall tax on utilities back in 1997 so utilities and oils are likely to be stock market sectors that are sensitive to any potential leftward swing in party policy, as are other regulated industries where levels of customer disaffection and frustration are running high.
“Increasingly vocal and forceful regulators, such as the Financial Conduct Authority, Ofcom, Ofgem, Ofwat and the Competition and Markets Authority, appear to be responding to public pressure for greater action, and perhaps the hardest part for investors going forward will be spotting which industry or sectors will come under scrutiny next, in the wake of such recent examples as betting, funeral services and veterinary services.
How have markets responded to past elections?
“A study of all sixteen of the general elections since the inception of the FTSE All-Share in 1962 shows that the UK stock market is by no means frightened of a change in government and it may even welcome it. On average, the FTSE All-Share has recorded a double-digit percentage gain in the first year after an election which sees one prime minister ejected from office and a new one ushered in. There are also greater average gains when a government changes relative to when it remains the same.
Source: LSEG Datastream data. *1964/66 to 1970 Wilson governments and 1974/74 to 1979 Wilson/Callaghan governments counted as one term. 2019 Conservative government to 22 May 2024
“Labour governments can point to healthy average stock market gains during the terms of their five prime ministers during the 42-year era of the FTSE All-Share.
“That said, the UK equity market has done better since 1962, on average, when the Conservatives have triumphed at the ballot box.
Source: LSEG Datastream data. *1964/66 to 1970 Wilson governments and 1974/74 to 1979 Wilson/Callaghan governments counted as one term. 2019 Conservative government to 22 May 2024. **Adjusted for retail price index (RPI).
“The role of inflation is important here. The 1974-79 Labour administration that began under Harold Wilson and ended under James Callaghan started off with a tiny majority but on paper generated healthy returns for the FTSE All-Share, which rocketed. However, once those returns take the RPI measure of inflation into account (and RPI is used as it offers a longer history than CPI), then investors actually lost out in real terms, in what was a difficult decade for shareholders, owing to the ravages of inflation.
Source: LSEG Datastream data. *Wilson initially PM with a minority of 33 after February 1974 and then with a majority of 3 after October 1974. Wilson stepped down in April 1976. **Wilson initially won a majority of 3 in 1964 which was increased to 96 in 1966. ***Blair stepped down in June 2007. ****Cameron’s majority relied on a coalition with the Liberal Democrats. He stepped down in July 2016. *****Johnson resigned in July 2022. Liz Truss took over in September 2022 and was replaced by Rishi Sunak in October 2022. ******May’s initial working majority was based on a deal with the DUP. *******Performance under current government as of 22 May 2024.
“Inflation also sorts out the real winners and losers, from the markets’ perspective, when it comes to individual prime ministers. Of the 13 prime ministers since 1964, four of the best five from the very narrow perspective of stock market perspective were Conservatives, once FTSE All-Share returns are measured in nominal terms.”
Source: LSEG Datastream data. *As of 22 May 2024.
