By Julien Ponthus
LONDON (Reuters) – British financial markets reacted calmly on Wednesday to the prospect of a snap election before Christmas after a fractious UK parliament finally agreed to a nationwide poll on Dec 12 that may help break the political deadlock over Brexit.
Opinion polls give Prime Minister Boris Johnson a 10-points plus lead over Labour party leader Jeremy Corbyn, but the final outcome is far from certain in light of recent election surprises and amid increasingly erratic voter behaviour.
Former premier Theresa May called an election in 2017 when opinions polls showed her ruling Conservatives ahead by a similar margin to Johnson now, but the end result was a hung parliament with no majority for any party. Parliament has struggled to pass any Brexit legislation as a result.
More voters switched between the two main parties in the 2017 election than in any ballot dating back to 1966, research by the British Election Study showed.
As of Wednesday, percentages derived from odds given by bookmakers William Hill, Paddy Power and Ladbrokes gave a 50% chance of Johnson’s Tories winning a majority, a 42.5% chance of a hung parliament, and a 5.5% chance of a Labour majority.
The overriding concern for investors is what the result will mean for the protracted and delayed Brexit process. But there are also price-sensitive policy initiatives and differences that will be at play for various sectors and companies.
Following are a number of scenarios for British stocks, sterling and bonds based on some of the possible electoral outcomes from December’s election:
BORISJOHNSONGETS AN ABSOLUTEMAJORITY
An outright victory for Johnson’s Conservatives, whose electoral platform is deemed the most market friendly, would likely boost UK-focused midcaps and weigh on dollar-earning blue chips, in a further reversal of the “no deal” Brexit fears that markets have grappled with since the 2016 referendum.
With a clear majority, Johnson could be expected to push ahead and secure his recently negotiated Brexit withdrawal agreement with the European Union.
Although it is seen as a relatively hard form of Brexit by excluding UK-wide customs union membership and other ties, the implementing the agreement would avoid a damaging ‘no deal’ British departure from the EU, instead paving the way for a relatively orderly exit at the end of January.
“One could assume a reversal to some extent of the 2016 referendum,” as a victorious Tory leader would be in a position to secure an orderly exit, said Stephen Message, a manager at Legal and General.
On June 24, 2016, the surprise 51.9% victory of ‘Leave’ voters sent the pound down about 8% and with it, the FTSE 250 midcap index, which slid more than 7% as the dire economic prospects of leaving the European Union spooked investors.
In the case of a Tory victory this December, catch-up would be in order for UK-focused companies such as housebuilders like Persimmon <PSN.L>, Barrett <BDEV.L>, Gleeson <GLEG.L> , Bellway <BWY.L> and Galliford Try <GFRD.L>. The sector could also benefit from planned tax cuts to help first-time buyers.
Domestic banks Lloyds <LLOY.L> and Royal Bank of Scotland <RBS.L> would be expected to do well too as the economic prospects improve.
Phil Harris, manager of the UK Equity Growth fund at EdenTree, said that ‘high-ticket’ retailers, for example DFS <DFSD.L> or SCS <SCSS.L> would also be expected to rise with a planned tax cut for the middle class.
While the pound isn’t expected to regain all the ground lost since it traded above 1.50 dollars before the referendum, a possible rise to $1.35 would weigh on the most internationalised UK groups, from consumer staples like Diageo <DGE.L> to big pharmaceutical groups such as GlaxoSmithKline <GSK.L> or miners like Glencore <GLEN.L>.
The pledge by Johnson’s government to cut taxes and put an end to a decade of austerity via increased spending in education, police and the National Health Service would also raise expectations of higher interest rates on corporate and government bonds.
CORBYNWINS AN OUTRIGHTMAJORITY
Given bookies and prediction sites put the chances of Labour leader Corbyn securing an absolute majority at as low as 5%, this would be the most surprising outcome and a potential shock for parts of the British stock market even if offset by Labour’s stance on Brexit.
On one level, sterling and Brexit-sensitive stocks may be buoyed by Labour’s plan to rule out a ‘no deal’, argue for a softer deal that includes customs union membership, and seek a second referendum that would include an option to remain a member of the EU.
But Corbyn’s broader manifesto is expected to be a relatively radical agenda to steer Britain’s economy to the left through large-scale nationalisations, tax hikes and reforms, and stricter regulation on business.
Consequently, even if a no-deal Brexit is ruled out and a second referendum on the cards, a surprise Corbyn victory would likely hit Britain’s main equity benchmarks due to an expected hit overall on corporate earnings growth but especially on sectoral indexes such as utilities.
“Sectors which are perceived to be in the political firing line would include the water, gas and electricity utilities, transport stocks (especially rail operators) and also Royal Mail <RMG.L>, given Labour’s campaign pledge to nationalise them and do so at below-market rates for good measure”, said Ross Mould, an investment director at AJ Bell.
The so-called Corbyn Risk Premium has long hung over Britain’s utilities which have only recently recovered in comparison with euro zone peers.
“A surge in the polls for Jeremy Corbyn could therefore pressure the likes of Centrica <CNA.L> and FirstGroup <FGP.L>”, Mould said.
Outsourcing companies such as Interserve <ISVJF.PK> or Serco <SRP.L> are also expected to get less business from a Labour government than a conservative administration seeking to further privatise the economy.
The same is expected for defence contractors such as BAE Systems <BAES.L>, QinetiQ <QQ.L> and Babcock <BAB.L> given Corbyn’s reluctance to engage in high military spending.
UK-focused high-end retail groups such as Pendragon <PDG.L> could suffer as well as life insurers <.FTNMX8570> should tax reform reduce the disposable income of higher earners.
Britain’s financial sector as a whole may be hit with tighter regulation and taxes, but it would likely be easier for banks with an international footprint such as HSBC <HSBA.L> to weather the storm.
No majority for either of the two main parties could be seen as a negative by re-igniting Brexit uncertainty and hence prolonging one of the worst political crises Britain has seen since the Second World War.
But the exact results of an inconclusive vote would be key to who exactly forms the next government and would affect whether formal coalitions could be formed. There are many ways it could unfold and impact markets.
In any event, retailers and all businesses for which Christmas sales are key may be heavily impacted.
The nightmare scenario for investors who want to avoid a no-deal Brexit at all costs would be that Johnson falls short, needs support to form a majority in Westminster and allies himself with Nigel Farage’s hardline Brexit Party that explicitly supports exiting the EU with no deal.
The prospect of Britain exiting the EU on WTO terms could trigger a steep selloff in the pound and the shares of domestically focused FTSE midcap stocks. <.FTMC>
REMAINALLIANCE? LABOUR/LIBERAL DEMOCRATS/SNP/GREENS
If the Conservatives fall well short of a majority and are unable to form a workable government, Labour, the anti-Brexit Liberal-Democrats and the SNP – and possibly other minor pro-Remain parties such as the Green Party – could try to form a coalition of their own.
Sterling and macro UK markets may greet such an outcome positively if they see that a ‘no-deal’ Brexit is off the table, a softer deal can be negotiated, and there is even the outside chance of a second referendum and Britain voting to remain in the EU after all. Many also reckon the Lib-Dems could keep Labour’s more radical programmes in check, limiting the hit to exposed market sectors and sentiment.
With a constituency that overwhelmingly favours remaining in the European Union, the Scottish National Party is expected to do well in the election with its firmly anti-Brexit stance.
If in any subsequent coalition talks, the SNP sought assurances on another independence referendum for Scotland in 2020, that could pressure sterling and Scotland-based companies such as Royal Bank of Scotland <RBS.L> and Standard Life Aberdeen <SLA.L>.
(Reporting by Julien Ponthus; Additional reporting by Danilo Masoni, Joice Alves, Thyagaraju Adinarayan and Saikat Chatterjee; Editing by Hugh Lawson)