We simply can’t avoid it anymore – let’s address the concept of political risk, and specifically the imminent general election (groan). Overall, I have grown increasingly cynical about the impact of politics on markets – many of us got Trump’s election completely wrong and since then I’ve been really cautious about macro musings focused on a whole range of things including Eurozone crises and the impact of trade tariffs. But politics does play an important role when we have two very contrasting political narratives on offer. When politics drifts because no one agree about two relatively sensible visions (think Belgium’s drift without a government which went on for an age), then markets might actually quite like political indecision.
But when we have two drastically contrasting populist narratives on offer – as we do with the impending UK general election – then I think investors do need to pay attention. I have no intention of burdening readers with my preferences on the parties battling for our votes, but I would simply observe that whatever the outcome I think most equity investors might fear a Corbyn win the most (that at least is the impression the Labour Party likes to give when talking about tackling faceless rich speculators). But the next most fearful outcome is another hung parliament or at best a deeply unstable Conservative majority government.
At this point, my first passion – geography – kicks in. I’ve always felt there’s a huge amount of fascinating work to be done around economic geography, especially around why some places and localities do well, and others don’t. Nobel winning economist Paul Krugman has certainly talked up this discipline. Political geography is also profoundly interesting as it encourages you to ignore all those varying national opinion polls and focus on battles at the constituency level. Last week emboldened by that passion for political geography I spent an afternoon crunching 2017 constituency data looking for which seats might fall in a big swing, based on current polling to the Conservatives.
The most important thing to say from the get-go is that there are probably only about 100 seats that are remotely competitive in the UK – by this I mean the winning party has a majority of less than 15% of the vote. If we then plug in the current prevailing consensus amongst investors – at the very least a 7.5% swing from Labour to Conservatives especially in two-horse race Midlands and Northern seats , plus a swing to Labour in the south in urban seats, alongside a small Liberal Democrat revival from 2017 in core urban Remainer seats – we end up with the Conservatives on something between 320 and 330 with Labour cruising towards 225 give or take 10 either way. The Lib Dems gain a few to hit 20 seats and the SNP increases its shares to around 48. To be more precise I can see how the Conservatives could win an extra 43 seats (2 from the LibDems and 41 from Labour), Labour wins 16 in the south (nearly all from the Conservatives) and the Liberal Democrats make a net gain of 8 with all bar one from the Conservatives).
There are quite a few assumptions that could easily be overturned in this analysis but one needs to remember that this general election is all about those 100 or so seats that are remotely marginal. Excited talk of a Conservative 20 plus majority would require an earthquake on the ground i.e seats with 20% plus Labour and Liberal majorities falling to the Conservatives. That could of course happen, but the probabilities at this stage are low.
Which leaves me with my gloomy warning. All things being equal, given current vote projections, political geography suggests that a hung or very small majority Conservative government is possible if not probable. Personally, I wouldn’t be terrifically opposed to this outcome (I share Martin Wolf’s views on the horrible choice facing voters) but from an investors’ perspective, this is terrible news. The one thing I think we can all agree on with the current election is that we need the uncertainty about stuff like Brexit (stage 1) to end. We need some resolution to the ongoing struggles if only because then businesses and consumers can then get on and start planning for the next few years. More uncertainty is a poison that could push UK equities even lower in relative valuation terms.
If you want the spreadsheet thus analysis is based on, drop me an email and I’ll happily share the underlying data.