An open goal?
It all looked so simple. An April opinion poll lead of around 19 percentage points for the Conservatives was validated by a crushing show of strength in the local elections, the flipside of which was a wipe-out for UKIP and a dramatic loss of seats for Labour (resulting in the loss of seven out of the 16 councils it held)*.
In calling a general election, May must have felt that this was an open goal: play on her leadership strengths, pour scorn on Corbyn, capitalise on the popular mood. It was also a chance to jettison the Cameron manifesto from the last election and to rebrand the Conservative party in her own image.
Tactically, it is a bit harder to know exactly what May wanted. However, some commentators have suggested that, with a bloc of more than 30 hard Brexiteers in her party and a majority from the last election of 14 seats, her room for manoeuvre in negotiations with the EU was severely cramped. An increased majority would potentially give her more room for compromise.
When the campaign started, markets were fairly sanguine that there would be an increased Tory majority, which would give political stability for five years, long enough for negotiations with the EU to take place and, in the best scenario, conclude, and for any new or interim arrangement to be put into place. May could then go to the country in 2022 trumpeting her achievement in delivering what the country had asked for in the 2016 referendum.
Roll forward four weeks and the picture has changed radically. With the launch of the manifestoes, the public found themselves disagreeing with the Conservatives over social care, prompting a swift U-turn by May, while they also found much to like in the Labour manifesto, which sought to refocus attention away from the EU and towards the conduct and funding of domestic policy.
The dramatic improvement in fortune for the Labour party in recent opinion polls is clearly evident, with a corresponding slide for the Conservatives. Most worryingly for Conservative strategy, the UKIP voters that May had relied on attracting appear, at the margin, to be returning to the Labour fold.
As we get nearer to the election date, the lesson of the last two years is to pay increasing attention to polls. One of the distortions in opinion polls (which pollsters are keen to downplay) is that early in campaigns the number of ‘Don’t Knows’ is usually high, but these are excluded from the arithmetic so that all the parties sum to 100%. As we get nearer the election date, ‘Don’t Knows’ come off the fence, and the evidence of the narrowing gap in polls suggests that they may be drifting towards Labour.
Strangely for a country in which the main focus for the last year has been policy on the EU, the exit negotiations do not appear to have played a major part in forming opinions, although this may be because both the Conservatives and Labour back an exit. Indeed, the Lib Dems, who are the only party to have made Brexit the main issue of their campaign, are losing ground.
All to play for
When we look at possible outcomes, the possibility that would be viewed as the most perceived market-friendly would be an increased Tory majority. This result would allow May to consolidate her hold on power and to have flexibility in compromising on some areas of negotiation in order to get the best deal for the UK, but it is looking less likely than two weeks ago, even though for the moment the party is still comfortably in the lead.
There is another reason to expect a continuation of Conservative rule, which is that the party can almost always rely on the support in parliament of the Democratic Unionists from Northern Ireland, who hold eight seats and back 90% of Conservative bills. Furthermore, Sinn Fein hold five seats, but they do not take these up. This makes the current Conservative majority of 14 seats something closer to 27 in practise.
The next possible outcome, which is no major seat gains for the Conservatives, or even a decline, is likely to be market-neutral. In this case, May would be likely to have very little room for manoeuvre in negotiations with the EU. Within the party, her authority may be weakened due to the reduced lead in the polls, especially because she has made herself the centre of the campaign and set out a lot of her own ideas in the manifesto.
The third possibility is that no party wins an overall majority, which would leave us with a hung parliament. Negotiations over forming a coalition would then start, but in these circumstances the chances of either Labour or the Lib Dems throwing in their lot with the Conservatives are very small—Labour for ideological reasons and the Lib Dems because of their experience of working as a coalition with them between 2010 and 2015. Labour might look at a deal with the Lib Dems, but the price of this would probably be a revisiting of the Brexit question, and in addition it may well be that the Lib Dems would view a stint as junior partner to the Labour party, having previously served as junior partner to the Conservative party, as a negative impact on their credibility.
If it gained enough seats, the Labour party might seek to do a deal with the SNP, although this would probably fall short of a coalition. The price of this would likely be a guarantee of another referendum on independence in Scotland, once the SNP had prepared the ground.
There is also the possibility—low, but not impossible, given current poll momentum—of Labour winning. In this event, there may be some headwinds for businesses, with the tax proposals in the Labour manifesto likely to move the UK down the competitiveness ranking relative to some other EU countries. However, the creation of a state-backed investment bank could help boost investment in infrastructure and lock in low current borrowing costs.
Focus on fundamentals
What the results from 2016 have taught us is that the impossible can become possible. The uncertainty continues, and the actual result will not be truly known until the votes have been counted. Investors will either bet on the outcome of this significant event or decide to stand back and take risk off the table until the landscape becomes clearer.
Either way, it cannot be said that the last 12 months have been boring. Whatever the result, we believe that investors will need to focus on company fundamentals to have the best chance of making the right investment decisions.
*Not all councils nationally had elections
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