Make no mistake, the future of the U.K. economy is hanging in the balance. Since yesterday’s general election ended with a hung parliament, Theresa May remains prime minister, but her position isn’t secure and party leaders will now begin negotiating power.
But while there’s now talk of May’s possible resignation and the chance of more elections, this isn’t the first time there’s been a hung parliament, reports BBC.
According to economist Todd Mattina, May’s election gamble “failed spectacularly” and has “cast some governance uncertainty.” As such, “the outcome of the election means it’s really unclear whether it will be bullish or bearish for the U.K. economy in the long run.”
The initial effect was “a sharp drop in the pound of about 2%, with the pound heading toward US$1.27. And we saw a modest reaction in the government gilt market, with 10-year gilt yields dropping very slightly by about one to one-and-a-half basis points.”
But, “while the domestically focused FTSE 250 dropped initially about 1% before recovering losses, the more internationally focused FTSE 100 actually gained by about 1% initially.”
So Mattina, who’s chief economist and strategist, asset allocation at Mackenzie Investments in Toronto, is positive on global markets. The initial reaction makes sense, he explains, “because about two-thirds of the earnings of FTSE 100-listed companies come from outside the U.K. A cheaper pound provides a competitive boost for those companies.”
For investors, one thing is clear: this surprise election reinforces that “it’s very difficult to forecast political risk and what it means,” says Mattina. “So it’s important to look at factors like the long-run fundamentals that are driving markets,” both in and out of the U.K. and Europe, and to refrain from trying to profit from geopolitical events.
Mattina’s portfolio is moderately overweight the FTSE 100, and that won’t change any time soon. “The reason is not related to political risk, but because the U.K. stock market has relatively attractive long-run valuations compared to other major markets. Our view is, at least historically, that markets that are cheap relative to their fundamentals have higher long-run returns, and this is the bucket the U.K. is in.”
Plus, the FTSE 100 has positive investor sentiment, says Mattina. Following the Brexit referendum, that market “was one of the best-performing,” partly due to the weak pound. “So we remain overweight in our portfolio, a position we’ve had for some time, and we will continue to hold that position.”
What’s next for Brexit and the economy?
The election result was a good thing, says Peter Westaway, chief economist and head of investment strategy for Vanguard in Europe.
“The reason is because the most important election issue was how [the results were] going to affect Brexit negotiations; everything else was a detail relative to that,” he explains. And, “we previously appeared to have a government that was hell-bent on delivering a hard Brexit,” says Westaway, even though they had a “weak majority.”
He says a hung parliament is positive in that “it could potentially benefit the Brexit negotiations because it means, suddenly, you might have the opportunity for a Labour Party or coalition [government].” Overall, “Staying where we were was the worst outcome, but the question is, Will this meaningfully allow the government to deliver a soft Brexit?”
One key factor, he adds, “is the new government is going to rely on the Democratic Unionist Party, a Northern Ireland group of MPs, who are pro-Brexit. They’re never going to vote against leaving, but there are a number of issues around the border of Northern and Southern Ireland which so far haven’t been sufficiently discussed,” regarding the free movement of goods.
A soft Brexit aside, Westaway is still cautious on the U.K. economy. There hasn’t been a shift to a full-blown Labour government—a move that he says “would have spooked the market” due to the party’s tax and spending proposals—so most economic policies will stay in place.
Earlier this year, Westaway had called for U.K. weakness despite positive data, and he stands by that forecast. At that time, he pointed to Brexit uncertainty leading to companies and households restraining spending, and to a possible recession in the second half of 2017 or in 2018.
Currently, says Westaway, “It seems like many of the things I talked about are playing out. Indeed, we had 0.2% growth in the U.K. in the last quarter, so that slowdown is coming through.” He cites drivers such as inflation, the lower sterling and “a squeeze on disposable incomes and consumption.”
All those trends are worth monitoring, Westaway concludes. But, “to the extent that last night has provided us with a little more hope, I’m more optimistic.”
Economist Todd Mattina agrees, saying that the U.K. risks are unlikely to spill over into global markets. “This won’t be a trigger for a global sell-off — certainly not at this stage, based on the reaction.”