General Election 2015 – the story so far

Officially the UK general election campaign is about halfway done, unofficially of course it is ion the final stages of a marathon that kicked off with the 2014 March budget and its new pension freedoms. There are some signs that the electorate have “hit the wall” with regard to tolerance for political points-scoring.

For the last twelve months the poll ratings for both Conservatives and Labour have remained roughly equal at 30-35% apiece. UKIP consistently poll in third place but their support appears to have peaked at the European elections last May and since then have drifted back from the high teens to the low teens, the Lib Dems and the Greens split a further 15%. The most important change barely registers in the national opinion polls but the SNP has seen a strong surge in support throughout Scotland following the defeat of the referendum vote on independence.

In terms of parliamentary seats, the peculiarities of the constituency-based, ”first-past-the-post” system are making their mark. According to electionforecast.co.uk the SNP with about 4% of the overall UK vote will win 47 seats whilst the Lib Dems with about 7% of the vote look set for 24 seats, while UKIP with about 14% will win only 1 seat, and the Greens who generally poll above the Lib Dems will hold onto their 1 seat. The Conservatives look set to win more seats than Labour (283 to 271) with a similar share of the votes, due to Labour’s losses to the SNP..

This looks likely to leave the country in a position where not only will no single party win enough seats for a majority, but quite conceivably the only coalition outcomes that would secure a majority will be Conservative / Labour or Conservative / SNP. Neither of these seem remotely likely to occur. The most likely outcome now is in fact not a coalition, but a minority government supported by other parties on an issue-by-issue basis.

The parliamentary arithmetic will be keenly balanced between those smaller parties willing to support a Conservative minority government in a vote of confidence, and those willing to support a Labour minority government. Miliband may well be likely to win fewer seats than the Conservatives but be more able to win a vote of confidence within parliament.

For some time now the Conservatives have been expecting to pull ahead of Labour in the polls as the economic recovery has taken hold, but this has failed to occur. There is a belief in Conservative circles that the last few days of the campaign will see a surge in support for them, when voters finally decide who to vote for. Indeed polls show that a large number of investors have not yet definitively decided how to vote. It seems though that the image of the Conservatives as the “nasty party” as Theresa May famously remarked, has not disappeared from many voters’ minds, despite good economic news.

As in the 2010 campaign, no party is prepared to give details of precisely where the future austerity which their economic policies require will actually hit – it seems they fear the truth on this is too painful for the electorate to bear.

More remarkable is the recent narrowing of policy differences between the two major parties. Having trumpeted the positive effects of sticking to their “long term economic plan” for so long, in the campaign Cameron has been very quick to make new campaign pledges for more money for the NHS, subsidies for commuter rail fares and reductions in Inheritance Tax. None of these previously appeared in the long term plan or appear to have been funded by savings elsewhere. Similarly Labour, having criticised the policies of austerity over the last five years, has placed bearing down on the deficit at the heart of its manifesto, and has resolutely refused to embrace any unfunded campaign pledges in order to demonstrate its fiscal responsibility. Both parties are seeking to win over the centre ground of voters – the Conservatives by showing by spending more and Labour by spending less!

Perhaps the most important statistic in this campaign is that more than 60% of the electorate (and an even higher proportion of those who will actually vote) are over 55 years old. For most of these voters it is pensions, be they provided by the state or by private provision, which are their critical focus. This is now probably a more important issue than jobs for this age group and is perhaps a factor in why the rising number of jobs is not feeding through into Conservative voters.

With two weeks to go, this election remains too close to call. The UK financial markets have been happy to ignore the political uncertainty to date – a minority government of any sort may be seen as a negative development by the currency and gilt markets on the basis that it will be difficult for the government to implement its policies. On the other hand a weaker sterling is usually good news for UK stocks and politicians who are unable to do anything could be seen as good news in that they are unable to mess anything up!

Drifting towards constitutional chaos

Typically markets give little consideration to political events until they are right on top of them, so it may now be appropriate to give some thought to the possible outcomes of the UK general election. Nationally the poll ratings for Conservative and Labour have been very steady for well over a year now, though ibn Scotland Labour have been losing significant numbers of voters to the SNP. A parliament of 650 MPs made up of approximately 280 Conservative, 270 Labour, 30 Lib Dem, 50 SNP and 20 other (15 Unionist and UKIP on the right, 5 Green and Plaid Cymru on the left) is close to that implied by the political betting markets and current polls, and would leave the UK political scene in a very uncertain state.

This would leave the traditional right-of-centre parties at 295, the Labour, nationalist and Green parties at 325 and the Lib Dems in the centre with 30. The implication would be that the only two-party coalition majority that could get close to a majority would be a Labour/SNP coalition; however the price of such a coalition would very likely be the break-up of the UK itself. Alex Salmond would be the SNP leader in Westminster and he has shown himself to be a very effective political operator in the coalition politics of Holyrood.

Sadly no other outcome looks good for markets either:

  • Traditionally the best outcome for markets would be a majority for a stable right-of-centre government. A Conservative majority, while looking extremely unlikely at the current juncture would however be one fraught with political and constitutional risk as the Conservative manifesto will commit to holding a referendum in the UK’s continued membership of the EU. The uncertainty that such a referendum would engender in the minds of business leaders would be very negative for investment in the UK, and a vote to withdraw is likely to be viewed very negatively by the UK financial markets.
  • A continuation of the present Conservative/Lib Dem coalition, is also not likely on the current poll ratings. It would however be likely to feed continued Scottish disgruntlement, where neither of the UK governing parties is likely to have much representation north of the border. Further demands for more powers for the Scottish parliament are also likely to be met with stronger rhetoric for English-only MPs deciding English matters, bringing the very concept of the Union under deeper strain.
  • A minority Conservative government would find it very difficult to get its economic and budget policies through parliament, where a combination of Labour, Lib-Dem and SNP votes would block most of their plans.
  • A Labour/Lib Dem coalition looks unlikely to have enough support within parliament by itself, it would be dependent upon support from the SNP to pass legislation and that support would come at a price. The same would be true for a minority Labour government.
  • A Labour majority would not be welcomed by financial markets as Ed Miliband is perceived as one of the most anti-business Labour leaders since Michael Foot.

Weak government and constitutional uncertainty look to be the only sure thing to come out of the forthcoming election. Weakness in the euro is the current flavour of the month in the currency markets, following the ECB’s decision to (finally) implement QE. By the time May is here, it may be they are seeking a new trend – weak sterling on the back of political uncertainty could well be that new trend.

UK economy – green shoots

Over the last ten quarters to March 2013, the UK economy has produced essentially zero growth due to a combination of (i) the UK government’s austerity plans encompassing both spending cuts and tax increases, (ii) severe economic weakness in the Eurozone, the UK’s largest trading partner, (iii) weakness in North Sea oil production due to essential maintenance work,  (iv) a large banking sector engulfed in a series of scandals, which have damaged their profitability, and (v) declining consumer real incomes

During this period the UK economy has consistently disappointed the expectations of the Bank of England, the Office of Budget Responsibility and the IMF, as well as many private sector forecasters.  In recent weeks however, this trend of disappointing expectations has come to an end, and the Bank of England, in Mervyn King’s last presentation of the state of the UK economy, upgraded its growth forecast for the UK in 2013 from 1.0% to 1.2%.

Beneath the headline figure of zero growth, there have however been two important improvements in the UK economy, which give encouragement to longer term recovery prospects as follows:

  1.  The structural budget deficit (that is after allowing for the extra government spending and lower tax revenues that arise from a weaker economy) has been reduced by over 4% of GDP in just 3 years (or 1.3% per annum) .Given that state spending is about 40% of the economy, it has required the other 60% (the private sector) to grow at about 1% per annum over this period, merely to offset the public sector weakness and achieve zero growth for the economy as a whole.  This 1% growth from the private sector is quite an achievement in the face of so many headwinds for consumer and government spending.  Though the structural budget deficit remains too high, there has been good progress in reducing it.
  2. The flexibility of the UK labour market has surprised many.   Despite the economic weakness, unemployment has stabilised at around 2.5m rather than the 3m that many commentators expected to see when the crisis first hit.  The major reason for this has been workers preparedness to take pay cuts or not demand pay rises to preserve their jobs – UK wages are only growing at about 1% currently, and have been well below the rate of inflation for four years. By contrast, French unemployment (France has essentially the same population and size of economy as the UK) has gone through 3m and is still rising.

The weather has played a surprisingly key role in the UK economy over the last twelve months – last summer was extremely wet (excepting the period of the Olympics) and both of the last two winters have been very cold and wet.  This has had a very serious effect on the construction industry, which had already been extremely weak over the life of this government, first from a cutback in government investment programmes, and secondly from weakness in UK housebuilding.  Just a return to normal weather over the summer and next winter should see a sharp improvement in construction spending, and with it the demand for construction workers, and the prospects for an improvement in overall economic growth.

There are other reasons though for being more confident. The electoral clock is now audibly ticking, and though the government will not reverse course on their austerity programme, they will be more sympathetic to ideas, which boost economic growth in the shorter term, particularly if they can be labelled as “investment”.  Importantly too, the new Governor of the Bank of England has been selected because he is an activist who believes that monetary policy can make a difference to the real economy. He has already been granted a more flexible mandate than just the control of inflation. Growth is now almost as important, and more emphasis on getting funds into the hands of industrial borrowers can be expected.

In the run-up to the 2015 election, there will be a more marked policy bias to boosting growth, and with the underlying improvements that can already be seen in the UK economy, it is likely that growth will exceed the (very low) expectations that currently exist. Note though that this is a forecast of modest improvement rather than of a boom.

The investment implications of beating the low expectations that exist for the UK economy are that, after two decades of performing much worse than either large or mid-sized companies, smaller companies in the UK, who are most exposed to the strength of the UK domestic economy, may be about to benefit most from the improving economic trends.  Where client portfolios do not have specific smaller companies exposure, we will be seeking to include it in any recommendations, as appropriate.