FTSE investors aren’t expecting big changes after Thursday

<p>Time and time again, stock markets in the lead-up and aftermath of virtually every general election since 1987 have backed-up the ‘truism’ that investors are […]</p>

Time and time again, stock markets in the lead-up and aftermath of virtually every general election since 1987 have backed-up the ‘truism’ that investors are averse to political uncertainty.

Ironically, it even applies right now, days away from another all but inevitable hung Parliament.

Whilst the UK stock market has evidently performed best during the last 28 years under governments with strong majorities – the FTSE All-Share Index gained more than 70% between 1979 and 1987 – the numerically irresolute coalition that has led Britain for the last five years is no longer a source of wariness for investors.

Uncertainty is the new certainty

At least we can be sure the character of the last government, as internally fractious and at times self-contradictory as it was, did not seem to be the most salient basis for investor decisions.

More recently, the anticipation of European Central Bank stimulus and, since March, its market-invigorating effects, are likely to have been a bigger part of the considerations of large UK investors.

Either way, for UK investors uncertainty has become quite a certainty and that is arguably reflected by gains of as much as 50% by the broad-based FTSE 350 stock index in the five years since May 2010.

This table put together by Ashraf Laidi showing FTSE 100 returns slightly before and one year after each election since 1983 seriously calls into question notions that the market has a pronounced political bias.

(Although, bear in mind the blue-chip index is only nominally tied to UK fortunes due to the number of globally operating firms among its constituents).

The average tendency of shares of the biggest UK-listed companies to rise in election years is clear, but there are striking exceptions.

And, if we recall some of the other major events that happened in those years (eg, 11th September 2001), it reminds us that market performance rarely, if ever, pivots solely on a change of government.

A glance at the remarks of a number of star fund managers who have gone on record about their investment intentions in light of the forthcoming poll reveals a wide spectrum of approaches.

Broadly speaking, these stances fall under the following categories:

  • An investor can see the election as essentially neutral for their strategy
  • They can fine-tune their portfolio for optimal defensiveness
  • They can emigrate – or at least sell out of ‘everything UK’
  • They can go ‘Crouching Tiger, Hidden Dragon’ and prepare to buy hard into any post-election falls

Institutional calm

Whichever way we choose to analyse market positioning ahead of the election, there is a strong impression that investors have once again remained largely pragmatic with an overlay of positivity.

In late April, a Thomson Reuters poll of 12 UK-based asset managers at large institutions, albeit not a representative sample, showed little inclination to flee UK stocks. Each expressed continued confidence in the ability of stimulus programmes around the world to continue cushioning markets – though, importantly, the emphasis was on globally balanced portfolios with UK assets playing a part, but not necessarily a central one.

The average exposure to equities in globally balanced portfolios remained at the high reached in March, 54.3%.

Respondents did cite some risks. They said an exit of Greece from the Eurozone, a deeper economic slowdown in China and a mistimed rate hike by the Federal Reserve, were potential events that called for caution.

None expressed specific wariness over the UK.

In fact, Reuters’ small poll seems in line with the findings of broader private surveys of large investor sentiment I’ve seen, conducted by such institutions as Bank of America Merrill Lynch.

‘Brexit’ feared the most

Despite what looks like a relatively sanguine attitude in the financial sector, we can’t ignore some persistent concerns by the corporate sector surrounding this week’s poll.

A survey by the British Chamber of Commerce found that 63% of 3,800 UK firms polled in February and March would see Britain’s exit from the EU as negative.

That was four percentage points higher than in the quarter before.

The survey results were qualified by more than a third of businesses saying they were averse to further integration with Europe, and more than half saying a reformed EU was their preferred option.

For UK-listed firms, such concerns could eventually be reflected in their stocks, but it remains to be seen how quickly investors would need to react to the risk.

The Conservatives have pledged a referendum on EU membership before the end of 2017.

Defence, housing, utilities

The list of potential nearer-term threats to specific sectors, following the election is well known, but these challenges have only emerged relatively late in campaigning, with publication of party manifestos.

Even then, ‘nearer-term’ should not be taken to mean ‘imminent’ or even ‘probable’ (remember, this is politics) for most of the sectors highlighted.

I’ve narrowed down the list of such threats to those that have the highest probability of being realised.

In doing so, I’ve considered only pledges by parties with a strong likelihood of forming the next UK government.

I’ve identified corporate sectors related to housing, defence and, marginally, consumer energy utilities as most prone to both positive and negative impact from post-election policy.

I don’t see any material, near-term benefit or risk for businesses in any other industry.

As for energy utilities, I’m mindful of not overstating the risks.

All consumer utilities in the UK and beyond have been subject to the increasing encroachment of regulation in recent years and that has been the case regardless of the political complexion of the government.

The regime for utilities is therefore unlikely to worsen (or improve) significantly under the next government.

It’s a similar picture for the banks.

Banks are feeling the sting of decades of excess and relatively lax standards. Again, since the end of the last decade, governments have sought to demonstrate their commitment to the consumer with one-upmanship on regulation that has left large banks with few political havens.

Once again, that’s unlikely to change for the better or worse (from the banks’ perspective) post election.

Policy hopscotch

The table below contains the stated policies that could pose risks to or potentially benefit energy housing or defence-related sectors.

 

Policy Sectors Risk Potential benefit Party
Freeze energy bills until 2017 and give energy regulator new powers to cut bills Energy utilities X Labour
Guarantee three-year tenancy agreements in the private sector and a ‘ceiling’ on rent increases Estate agents X
Get 200,000 homes built a year by 2020 Estate agents, house builders, mortgage lenders Tick mark Conservative
Prioritise capital investment in housing to build more affordable homes X Tick mark Labour
Prioritise local first-time buyers in new housing areas X Tick mark
Extend the ‘Right to Buy’ to 1.3m housing association tenants in England Tick mark Conservative
Get 200,000 homes built for first-time buyers aged under 40, at 20% discount X Tick mark Labour
Bring in £14bn from tax rises on corporations and the wealthy, and reduced tax avoidance All corporate sectors X Lib Dem
End continuous at-sea nuclear deterrent, enabling a cut in the number of submarines Aerospace and Defence X Tick mark
A ‘minimum, credible, independent nuclear deterrent’ based on continuous patrols X Tick mark Labour
Strategic Security and Defence Review X
Bring a second new aircraft carrier into active service Tick mark Conservative
Replace Trident with four submarines to maintain continuous at-sea nuclear deterrent X Tick mark

Everybody loves estate agents (and house builders)

So, potential benefits for house builders, estate agents and mortgage lenders (including banks) appear under all major policy scenarios.

These go hand in hand with risks for policies intended to stimulate lower-cost home ownership, or affordable housing, as such homes tend to provide lower margins for developers. The impact of rental sector restrictions, should they actually occur, would be obvious.

As for the Conservatives’ Help to Buy Isa idea in its current form, I suspect its likely impact either way for related sectors would be marginal.

The relatively small amount of projected government revenue to be gained, and the limited number of properties that Lib Dems’ and Labour’s tax on homes worth more than £2m would apply to, is the reason why I’ve left this policy out too.

The defence industries also face mixed fortunes. Maintenance engineering providers, like Babcock International Group Plc, for instance, would need to ensure they’re well positioned to capitalise on the ‘best-case’ scenario represented by Conservative policies.

Snapshot

With all of the above in mind, and less than a couple of days to go before another all-but-inevitable hung Parliament, we had a rare opportunity to take a look at major trends in UK stocks in the run-up to the poll.

This could give us an idea of what the market on average currently calls ‘defensive’.

The simplest and most direct way to measure that was to compile aggregate returns from UK corporate and industrial market sectors.

We used Global Industry Classification Standard (GICS) categories and the FTSE 350 index as benchmark.

The FTSE 350 is by nature a wider list of UK-listed stocks than the FTSE 100 and will tend to be more representative of British Big Business than the FTSE 100, for reasons explained above.

We used a three-month timeframe in the run-up this week’s elections, to allow adequate time for investor biases to form.

Our survey measured the total average return of each FTSE 350 GICS sector between 27th January and 27th April.

We also measured the ‘weight’ of each sector in terms of its percentage contribution to the whole index, enabling us to put any sharp industry group performances in proper context.

Finally, for reference we conducted the same exercise on the equivalent time period of the previous general election in 2010.

And we repeated the study to cover the three months after 2010’s poll too.

Situation normal

The big question was of course: ‘were the main corporate worries and hopes around Election 2015 reflected in the market by sector inflows or outflows?’

The only fair answer is that, in most instances, investors bought into and sold out of sectors in line with expectations.

But it also emerged that GICS groups might not be categorical enough. For instance, residential mortgage lenders, estate agents and banks were subsumed under Financials, though we know one industry has done significantly better than the other in recent years.

Here are the results of the snapshot in graphical form:

FTSE 350 sectors three months before Election 2015

FTSE 350 sectors three months before Election 2015

FTSE 350 sectors three months before Election 2010

FTSE 350 sectors three months before Election 2010

FTSE 350 sectors three months after Election 2010

FTSE 350 sectors three months after Election 2010

It’s probable that shares like Savills, the full-service property firm, listed among ‘financials’ flattered the poor showing from Barclays and its peers.

Predictably, the utilities sector performed the worst in the last three months.

Unloved utilities, battered banks

(N.B. the ‘Uncategorised’ group consisted of stocks with no GICS sector. Most in this group were listed funds and investment vehicles).

Having completed the exercise, the most important thing to grasp now is that much of the positioning revealed by this snapshot emerged when the balance of probabilities for Thursday’s poll were more tenuous than now, a couple of days before 7th May.

Crucially, in the last week or so, polls have begun to signal a lead by the Conservatives, albeit a tiny one: a percentage point at most.

Election Truism No.2: polls cannot predict the outcome of elections. Nonetheless, they have often been good indicators.

On that basis, we might expect at least some of the sector biases and shortfalls we observed to begin to unwind – now the return of the incumbent government, in some form, seems more likely.

The biggest potential opportunities in that respect could lie in the utilities sector. However, these are also of course amongst the biggest risks.

Big listed utilities have clearly lost some of the speculative appeal seen in the second half of last year.

Should that return, many utilities – especially the water providers like United Utilities – could again be weighed by investors who think they would fit well with infrastructure-focused investment funds with a record of buying such assets.

Among banks, there will come a point when Barclays, Standard Chartered and HSBC have been sold enough, and the value of their wider assets and businesses beyond the UK will again be better reflected in their shares.

That will come earlier for some lenders than for others.

IT buys getting crowded

Weak Aerospace and Defence stocks like BAE Systems and BBA Aviation (down in single-digit percentages since January) alongside serviced-offices provider Regus (+25% in three months) in the GICS ‘industrials’ sector, also gave a misleading impression.

Many of the other sectorial results were in keeping with trends in place long before election campaigning began in earnest.

For instance, Consumer Staples includes the beleaguered UK supermarkets.

In an environment of low-inflation that looks set to last for several months more, the Consumer Staples sector could offer strong risk-reward, in select cases.

Again, the strength of Materials largely reflects the relative rebound of the mining sector after a horrendous 2014 (a similar dynamic applies to the Energy sector, though the modest aggregate comeback there suggests some unrecognised potential in select cases.)

Finally, Information Technology seems by deduction to be the one sector whose ‘story’, on the face of it, is the weakest.

As usual, certain companies will look more prone to the risk of a significant unwinding of beneficent sentiment for high-profile IT stocks than others.

The engineering software maker Aveva Group was by far and away the best performer of this group over the last three months, outperforming the index and its sector with a surge of 31%. Peer Micro Focus added 20%.

 

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