Election Jitters

06/02/2015 at 5:24 pm

Political risk is a familiar concept to investors in certain contexts. Unrest in the Middle East which has an impact on oil, arbitrary rule in Latin America, and more recently excitement in Europe and strife in Ukraine are well-worn talking points which have had material impact on price behaviour from time to time.

Less familiar, though now certainly being talked about more and more, is the political risk associated with the forthcoming general election in the UK. The association of election results with movements in the London stock market seemed to have gone out with flared trousers and the FT 30. But this week, high-profile business leaders have added public weight to the private concerns of an increasing number of market participants that a Labour, or Labour-led government under Prime Minister Miliband would see a return to the kind of soak-the-rich, wage-and-price control maladies which made Britain the sick man of Europe forty long years ago.

We can return to those fears shortly.

Another reason for concern in the minds of some is the level of uncertainty associated with May’s result. The standard methodology for forecasting election outcomes is the “uniform swing projection”, under which the change in vote share since the last election as indicated by opinion polls is applied to each individual constituency. At present, this would give a hung parliament with Labour short of an outright majority by one seat.

As anyone who follows the news will be aware, however, uniform swing projection is shaping up to be a particularly poor guide to the new parliamentary makeup due to hit us in 2015. Taking the most obvious example, the national vote share of the SNP is minimal at around 5%, but within Scotland – which will return 59 out of 650 MPs – they are about bang on the 45% they polled in the secession referendum. With the unionist vote split three ways and more this puts them in their strongest ever position and they are expected to take most of Scotland’s seats. On the other hand, while the strength shown by UKIP over the last couple of years has received a lot of coverage, they do not possess the regional strength necessary to translate a national share of 15% into seats won under first past the post beyond a handful.

Betting markets are a great place to look for how this might translate into outcomes. At the time of writing, Paddy Power odds for Conservative and Labour seats put both parties on about 280, well short of the 326 required for even the most slender and unsustainable of majorities. Money is on the SNP to hold the next largest number of seats, though at only 40 this would still leave them short of being able to form the very weakest of two-party coalitions. Next come the rather emaciated Liberal Democrats at 26 (down from 57 won in 2010), with the other parties all in single figures. Try to translate this into outcomes for government of the country and markets are all over the place: shortest odds are for a Labour minority administration or a continued Con-Lib coalition, though even those manage only 4/1. There are then ten less likely scenarios before one gets to the “Grand Coalition” outcome – a Tory / Labour love-in – offered at a princely 50/1.

The current market, then, is for chaos, and if history is any guide this will mean bickering stagnation for a few months and a fresh election thereafter. Now stagnation is the opposite of uncertainty. The postponement of real change to the country, therefore, would deliver no fundamental grounds for a shift in financial markets relative to where they are today.

Back to the “nightmare scenario” of a Labour victory, in whatever sense. They recently committed by way of a Commons vote to keeping deficit reduction plans in place, simultaneously stating that this was absolutely in line with their own budgetary goals, while distancing themselves from specific Tory policies. The Conservatives, meanwhile, claimed that although Labour had walked through the lobbies promising to reduce the deficit on exactly the same trajectory as themselves, they couldn’t be trusted; and even if they could, would fail to deliver through politically-driven changes to basic concepts of arithmetic which were understandably difficult to clarify.

In other words, on the key issue of the sovereign balance sheet, both parties are in lock step: we would take exactly the same course, but the other guys would do it with a sillier walk. This is the edifying situation in which the mother of modern democracy now finds itself.

Let’s look at some of Labour’s “frightening” policies. They have made noises to the surviving disciples of the late Eric Hobsbawm about re-nationalising things but EU competition law extends to so many areas of the economy nowadays – including the railways – that it is not clear how this might be constitutional and such efforts would certainly meet with legal challenge as a result. 50% top tax is no innovation, and the Tories’ own home purchase duty changes from their most recent budget are in absolute philosophical step with Mr Miliband’s “mansion tax” in this area, and over time would have a similar effect on those perennially plunderable plutocrats at the top of the mythical money tree.

There is much more that could be said along these lines, but to refocus attention to market behaviour let us end with two observations.

Firstly, some of the mouthier rich always protest publicly at the prospect of Labour administrations. Lord Lloyd Webber, for example, famously suggested in 1992 that he would emigrate should Labour win the election of that year. Perhaps it was because of his contribution to the ensuing Conservative victory that he thankfully chose, in the aftermath of the 1997 Labour landslide, not to do so. (In the instance of this year’s contest, one of the higher-profile mouthpieces has taken the sensible precaution of neither being born nor dwelling here to begin with.) In any event such protestations bear even less relation to the economic outcome for the country than they do to election results.

Secondly, there really was the prospect of serious political change in the United Kingdom recently when the referendum on Scottish secession threatened to reduce it to the more traditional “Union of Crowns”. There was even one especially interesting weekend over which the SNP looked to be winning.

Markets did nothing as a result.

It looks certain that May of this year will bring forth a black swan to exercise temporary notional control over the government of Britain. As readers will know, it is otiose to try to plan for black swan events. It is equally otiose to expect a stagnant quagmire to yield volcanic change, or for parties wedded to near-identical policy platforms on key matters to make too much of a difference to (say) the earnings of Vodafone, the path of the RPI index or the yield on the ten-year gilt.

This year’s general election will be exciting for those whose emotional perspectives allow for that reaction. But anybody who thinks it will be anywhere near as exciting, or dangerous, for financial markets should consider calming down.


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