UK election preview May under pressure

What a difference a week makes, this time last week Theresa May’s Conservatives were enjoying a 20-point lead over its nearest rival Labour. Fast-forward seven days and the Conservative manifesto released last Thursday, has gone down with voters like a lead balloon, and now pollster Yougov is saying that Theresa May only has a 9-point lead over Jeremy Corbyn.

UK election outcome not a certainty

While a 9-point lead could still give Theresa May a comfortable victory on 8^th June, the fact her lead has been slashed in half in just a few days may reinforce to financial markets that her victory is not a certainty. With three weeks to go before the election, another bad PR week for PM May and her team and the Tories’ lead over Labour could fall further into the low single figures, which could encourage sterling selling ahead of this crucial vote.

Why May matters for sterling traders

Late on Sunday night the pound’s reaction had been muted, we need to wait for the UK traders to get in to get a sense of their concern. However, at one point GBP/USD had dropped below the crucial 1.30 level. A weakening of the pound on the back of a poor showing in the polls for Theresa May would not be surprising, after the Prime Minister announced the election last month the pound has risen 500 points versus the USD. A landslide from May soothed sterling traders’ anxieties as it removed the prospect of a rushed Brexit deal to fit in with an election that otherwise would have been due in 2020. It also meant that Theresa May would have been handed a stronger mandate that could have silenced some of the harshest Brexiteers in the UK backbenches that could have made negotiations with Europe a little easier for the Prime Minister. If these scenarios fail to develop, then the pound’s march above 1.30 could be disrupted, at least in the short term. We would expect to see a further retreat on Monday, potentially back to the1.2860 support level for GBP/USD, the low from last week.

Whether or not GBP/USD falls below this level and back towards 1.25 may depend on how well team May deals with this polling shock. Will they role back on some of the more controversial elements of their manifesto such as social care and pensions changes? If so, this could help her to regain the upper hand in the polls. Right now, sterling’s reaction to this election won’t be on the minutia of policy put forward by each candidate, but by May’s expected margin of victory. If this continues to narrow then the lead up to the election could be a challenging time for sterling.

The political impact on UK stocks

Over the coming weeks, we will be looking closely at how UK stocks may perform on the back of this election. Right now the key question is does politics really matter when the economy is doing well and has easily outperformed expectations of a slowdown post the Brexit vote, and corporate earnings have surprised to the upside in the first quarter of this year? Elections come and go, it’s the fundamentals that really matter, and right now the fundamentals look good for the UK.

However, it is worth noting, that those companies in the FTSE 250 that earn the majority of their earnings in sterling, have not seen their share prices return to highs from before the EU referendum, suggesting that Brexit, and not this election is a key concern for corporate performance in some sectors of the FTSE. One noteworthy company that remains in the red since last year’s Brexit vote is Easyjet, its share price is still 18% lower than it was on June 23^rd 2016. The homebuilders, who were also hit hard by the UK’s decision to leave the EU, have only recently managed to recover to their pre-Brexit levels. Below we give our view on some of the key sectors and stocks in the UK market and how they may react to this election.

The FTSE outlook:

The FTSE does have a more direct peg to British politics and economics and it can be found via its large consumer industry stocks. These include retailers, consumer care and health care shares. Investors reasonably perceive these to be sensitive to changing consumer sentiment. However, the outlook for a strengthened Conservative majority adds another wrinkle because the party’s just-released manifesto makes clear that austerity is here to stay. Real wage growth, having been under pressure for years, is likely to remain so for the foreseeable future, not least because of rising inflation. If we accept that the Brexit process could have a chilling effect on the broader economy and on consumption in particular, the outlook for consumer industries is problematic.

Before we get too pessimistic though, it’s worth noting that the most up-to-date official Retail Sales release showed that after a pause in the first few months of the year, shoppers were back in force in the spring. Sales rose 2.3% in April the biggest monthly rise since January 2016. Warm Easter weather helped encourage consumers to continue the trend that has given the economy impetus, certainly since the Brexit vote, but in fact since the financial crisis too.

Even so, the best-performing retail share so far this year is Burberry, with a 15% rise, reinforcing the FTSE 100’s UK disconnect. Whitbread, the operator of hotels, restaurants and the Costa Coffee chain, is next with a 10.64% rise. Despite a sharp fall last month after it warned about the impact of a tougher consumer environment, the group has outperformed the sector in 2017, partly due to perceived advantages from a recovering pound and from resilient consumer data.

Sainsbury’s, which has a more significant British footprint, is the most elevated high street retailer so far, rising 10%. Marks & Spencer is a few tenths of a point below. It is not Sainsbury’s supermarket arm that investors are interested in, since the group’s grocery business is underperforming rivals. Argos, which Sainsbury’s bought last year, is the likelier reason why the group’s stock has revived after a weak start this year and underperformance in 2016. Double-digit sales growth at the general retail chain is outpacing the market. Still, we have to look outside of the FTSE entirely for more dynamic stock price returns and cash flow growth among retailers. FTSE 250-listed JD Sports’ cash flow growth over five years clearly stands out in the sector. It’s no coincidence that the stock is up 75% over a year, with 40 points of that in this year.

Homemakers

Property market sentiment is another important political conduit to the FTSE 100. Direct government intervention in the property market and sensitivity to economic sentiment means that Britain’s residential property groups are uniquely exposed to UK voting.  The sector has retained most of a gain of about 500% since 2010, despite cooling off more recently, and by and large house builders’ shares have been good stores of value across the board this decade. Still, almost all house builders have expressed caution about the impact of Brexit. Many are switching focus to developments outside of London. Land values in the city are predictably the highest in the country, and the capital has seen house prices fall the fastest in Britain since the Brexit vote. London is also at the centre of an ‘affordability crisis’ in the wider South East, which could lead to a sellers’ crunch if the economy weakens as the UK leaves the EU.

The larger developers, Persimmon (the largest), Barratt, Taylor Wimpey, Berkeley Group (most exposed to the London market) and Bellway will inevitably attract more attention as 8th June approaches. Valuation and momentum disparities are likely to see Barratt and Taylor Wimpey close a modest percentage point gap between them and the highest gainer in the year to date, Persimmon. The FTSE’s top four house builder shares have risen 29%-37% this year, but they are still likely to be seen as having amongst the highest risks to the upside if the Conservatives win an improved majority. Berkeley Group Holdings is up a tad less than 20% in 2017.