Perhaps more than most votes, this one could prove to have significant implications for investors. As we approach the third general election in four years, here are a few key themes – Brexit notwithstanding – that could have a bearing on your UK investments over the coming years.
Higher public spending looks certain
Whoever wins the upcoming election, or whatever ‘colour’ coalition of parties ends up in power, it seems clear that the next government will hasten an end to almost a decade of austerity. Across the political spectrum, from the Greens to the Brexit party and everywhere in between, there seems broad consensus on the need to raise spending on public services and to invest more in the UK’s infrastructure.
Admittedly, parties diverge in the scale of their ambitions. Conservative plans to raise spending on long-term infrastructure projects to 3% of GDP (gross domestic product, a measure of national economic output), or around £25 billion more than current spending, look modest compared to Labour’s proposed £250 billion to fund a “green industrial revolution” on top of £150 billion for investment in schools, hospitals and housing.
Whatever the outcome of the election, it looks certain that UK government spending will rise. Over the shorter-term, higher government spending would normally be expected to boost the domestic economy, and therefore UK-focused companies. Depending on capacity in the UK economy, however, this extra demand for goods and labour could lead to an uptick in inflation. If so, the Bank of England may respond with higher interest rates in due course.
Unless new or higher taxes are introduced, opening the spending taps is also likely to mean greater government borrowing. Assuming the UK government covers its deficit by issuing more debt, in the form of bonds known as gilts, we would expect gilt prices to fall (as they become less scarce), and therefore their yields to rise (as bond yields move inversely to prices). As well as hitting investors who own them, higher gilt yields would probably be reflected in higher yields on corporate bonds (and other assets) whose prices are largely determined relative to gilts.
Nationalisation is possible
While the possibility of Labour winning an outright majority has been widely discounted, the opposition party’s commitment to renationalise many industries has already moved markets.
On top of its existing pledge to bring the energy, water and railway industries back into public ownership, Labour has promised to deliver free high-speed broadband to every home and business by 2030 by nationalising the company that operates the UK’s core network. It is not just Labour. The Greens also pledge to fully renationalise rail companies, for instance, and the Scottish National Party want to create state-owned energy and transport companies.
For investors in UK utility companies, nationalisation could represent a threat to the value of their shares, depending on whether any future government would pay full market price to take the company in state hands. To varying extents, share prices will already factor in the perceived risks.
The Confederation of British Industry has estimated the cost of Labour’s proposed renationalisation programme to taxpayers to be £196 billion. Assuming the government would borrow to finance its plan, there could also be an effect on the issuance – and therefore the price – of gilts.
And what about the pound?
It has been a relatively tumultuous time for sterling over the past few years, with the value of £1 oscillating between US$1.20 and $1.40. While the result of the 2016 referendum led to a sharp fall in the pound, this is no indicator of what may happen after this vote.
Trying to predict the direction of global currencies relative to one another is notoriously difficult, since their values are materially shaped by sentiment and speculation, especially over shorter periods. Moreover, it can be difficult to gauge the extent to which ‘good’ or ‘bad’ news is priced into currency values today.
Fundamentals like supply and demand would be expected to shape currency values more over the longer term. With respect to the trajectory of sterling, there are opposing forces that lead to competing views. On the one hand, many indicators like the Economist’s Big Mac Index point towards the pound being undervalued today. Conversely, the UK’s persistent balance-of-payments deficit – imports exceeding exports – points towards a long-term weakening of the currency.
While this election will have an important bearing of many of the forces shaping sterling’s value, it is important to remember that short-term currency speculation carries significant risks.
Keeping the election in perspective
Elections are a healthy reminder of why it can be prudent to not rely entirely on any single market, even the UK, for your financial future.
By ensuring your investments are allocated in a diversified way, across different types of assets across a range of countries and regions, you can avoid being hostage to domestic politics and any changes in the value of sterling. After all, the fate of the global economy will not be determined by the outcome of this election in the same way that the UK economy might be.
While it cannot guarantee against losses, diversifying your portfolio effectively – holding the right blend of assets to navigate the volatility of markets – will probably help you achieve your long-term financial goals.