FTSE braces for Election uncertainty

You must be aware by now of the growing political and economic policy risks emerging from a government led by either Labour or Conservatives in next month’s general UK General Election. Dealing with the challenges associated with a Labour-SNP coalition (fiscal tightening for businesses and the wealthy & likelihood of undershooting budget targets) and those from Conservatives (pushing for referendum on UK’s EU status) has already become a topic of discussion among traders, to the extent that they no longer cast such a negative spell on the market.

Getting used to the sound of Labour- SNP?

The fiscally restrictive approach towards balancing the budget is largely aimed at the wealthy (reversing the cut on top income tax to 50p from 45p, mansion tax on properties above £2mn and bank bonus tax), which is not seen as friendly to financial markets.  The elimination of non-domicile tax treatment could impact over £8.0bn in paid tax, a considerable chunk in addressing budget concerns.

But a growing minority of City insiders have voiced support for reforms/removal of non-doms treatment on the basis of addressing the inequality between Britain’s rich and poor– particularly that between those born in and outside the UK.

Beware of “Brexit” risk & Neverendum

Another source of support for Labour from businesses and City owners is ensuring the elimination of uncertainty associated with Conservatives’ insistence to hold a referendum determining UK’s membership in the EU. Despite Conservatives’ market-friendly policies, victory for Pm Cameron would be synonymous with “Brexit” risk, as the Party is committed to hold an EU referendum by the end of 2017. The repercussions of a Brexit would be damaging for the UK economy and market confidence, considering the UK’s role as a destination for large and medium sized global businesses, which export to other EU countries.

And even if opinion polls indicate a small majority against Brexit, the mere uncertainty and heightened buzz from the pro-Brexit campaign could hamper business confidence, halt investments and delay hiring. Compounding those fears, the leading credit agencies (Moodys, S&P and Fitch) have raised the likelihood of a downgrade in Britain’s sovereign rating in the event of a Brexit.  And last but not least, if the referendum keeps the UK in EU by a sufficiently close margin, then lingering fears of renewed referenda could create a lingering EU-risk premium, prompting businesses to leave the country as was the case in uncertainty-hit Quebec in the mid-1990s.

When minority government isn’t all that bad

One way a Conservatives victory could fail to bring EU referendum forward is in a minority-led Conservative-led government. In this case, the pro-EU Lib Dems would refuse to send a Referendum Bill through parliament, which would be part of a deal with Tories when forming the minority government.

Conversely, and more realistically, a Labour minority government in coalition with SNP will eliminate “Brexit” risk and could only be seen as positive if Labour remains on the path to meet the fiscal targets from the Charter Budget Responsibility. But if the SNP succeeds in imposing a banking levy as well as corporate tax surcharge, then the extent to which legislation is enacted would determine the reaction in the markets.

FTSE Technicals

•    Best case scenario from Tories win without aggressively pushing for EU referendum (or minority-Led government headed by Tories) may lift index to top of rising 5-year channel at 7,450, especially if Bank of England removes rate hike uncertainty from 2015
•    Negative scenario to break December trendline support and extend towards 100-week MA of 6,667
•    As the table shows below, the 2005 Election was the only time when the FTSE-100 rallied before and prior to polling day. In the six and 12 months following Election Day, the FTSE100 was higher in four of the last six elections