Well Britain is about to vote – again.
Thursday’s election is part of a trio of events markets will be watching and indeed, any one of them (the other two being the Comey testimony in the US and the ECB meeting) could move markets materially.
“This will in fact be the third year in a row Britain will have a major nationwide vote — fourth if you include the 2014 Scottish independence referendum, where voting took place only in Scotland,” WaPo notes, before reminding you that Theresa May’s decision to hold early elections likely stems from a desire to “extend the Conservatives’ majority in Parliament as she negotiates Britain’s exit from the E.U.” and the need to avoid having a vote in 2020, which would could “possibly [land] in the middle of complicated Brexit negotiations.”
As The Telegraph goes on to write, “at the start of the campaign some polls had the Tories at almost double the vote share of the Labour Party, indicating the most likely outcome would be a landslide victory that would increase Prime Minister Theresa May’s current working majority of 17 in the House of Commons, [but] May’s lead has dropped from 17.8 points to below 10 since she called the election on April 18.”
That last bit will be a concern to party headquarters.
It’s also a concern for markets, as traders fear a hung parliament could send the pound plunging to $1.20.
Here’s a summary of analyst views on potential outcomes via Bloomberg:
Conservative Win (Large Majority)
- As a Tory win seems already priced in, there’s limited scope for sterling to rally on the news; still, this outcome is seen as the most positive for the pound immediately after the vote
- Sterling is seen reaching $1.3100, according to the median of analyst estimates, with one predicting it to reach $1.3300, a level last seen in September 2016
- “In the markets there is a very simple rule of thumb: the larger the Conservative majority becomes, the more positive it is for sterling,” says Adam Cole, London-based head of global foreign-exchange strategy at RBC
Conservative Win (Small Majority)
- This outcome, which was once seen as a tail risk, is now very much on the market’s radar as Labour is slowly chipping away at the Tory lead in polls
- Yet, the pound isn’t expected to slide as a Conservative victory will still likely mean investors would wait for the Brexit negotiations to start for a better sense of how to trade the currency
- The definition of what a small majority is also differs from analyst to analyst
- The pound is seen at $1.3025, not far from current levels
- This could be particularly damaging for the pound as it throws not only the future of the government in question but could also complicate and possibly delay the start of Brexit negotiations
- The range of forecasts is the widest under this scenario with RBC’s Cole seeing the pound falling to as low as $1.20. The median signaled a drop to $1.2350
- With all the risks of a hung parliament, “being underweight the pound makes sense,” says Andrew Balls, chief investment officer at Pimco
Labour Party Win
- A Labour win will hurt the pound in the short term, but could boost it further down the line as markets welcome the prospect of a softer Brexit and a boost to fiscal spending
- “I think once the dust settles, the market will not see Labour as such a bad result,” said Jordan Rochester, a foreign-exchange strategist in London at Nomura Holdings Plc
- While an outright Labour win seems unlikely, a coalition with the Scottish National Party or the Liberal Democrats is considered possible
- The median projection was $1.2484, which is slightly higher than the prediction for a hung-parliament scenario
- The forecasts ranged from $1.33 to $1.23, with analysts divided on whether the prospect of a soft Brexit under a Labour government will support the pound or the ensuing uncertainty weigh on it
So that’s FX.
As for equities, Goldman has a piece out looking at how UK stocks are priced ahead of the vote. Here are some useful excerpts…
It is worth looking at how the market has priced the recent moves in the polls. As the lead of the Conservatives in Opinion Polls has narrowed (we use an average of Polls from Suravtion, YouGov, ORB, Ipsos and Panelbase), we’ve seen UK domestic stocks (GSSTUKDE) underperform and sterling weaken (Exhibit 1 and 2). Of course, this could all be unconnected to the polls; we do not have sufficient data to really test this hypothesis.
In the meantime, FTSE 100 has risen consistently over this period (Exhibit 3). We see this as a function of the fall in sterling; other drivers, such as commodity price moves, have not been supportive for FTSE 100 performance in recent weeks given both Oil prices and industrial metals prices are down since mid-April. Exhibit 4 shows FTSE 250 vs. FTSE 100 with the polls: while FTSE 250 has underperformed as the Conservative lead in the Polls to Labour has narrowed, the relationship here is much weaker than we found with UK domestic names. We would emphasize that FTSE 250 companies have large external exposure – c.50% of sales compared with 70% for FTSE 100.
Why are domestic stocks more vulnerable?
If uncertainty rises we’d expect sterling to fall. Sterling rose when Theresa May called the election, as the polls initially pointed to a decisive Conservative victory with an enlarged majority. Our economists have argued this move up in sterling was partly driven by the view a stronger majority would allow Theresa May to better negotiate a transitional arrangement with the EU and prevent a ‘cliff-edge’ Brexit in two years time. A smaller majority or a hung parliament would make this more difficult.
We find moves in the currency are the biggest determinate of UK domestic relative performance. The FTSE 100 has on average 70% external sales exposure and hence these stocks gain, at least in translational terms, when sterling falls. UK domestic companies by definition gain nothing from the fall in sterling and they tend to be large importers of raw materials. Our basket of UK domestic names (GSSTUKDE) has average domestic exposure of 96%. As Exhibit 5 shows, the link with GBP/USD and relative domestic company performance has been strong over the past 18 months. The impact on the price level of FTSE 100 of FX moves has varied over time. But in recent months the correlation has been strongly negative – falls in sterling benefiting FTSE 100 performance (Exhibit 6).
Domestic stocks are especially vulnerable to import price inflation. Rising import costs, as shown in Exhibit 7, tend to be strongly negatively correlated with consumer sector and more domestic-facing company performance.
Are domestic stocks cheap? And does this mean they bounce if Conservatives win a majority?
Domestic-facing UK companies trade on a small discount to the market, based on 12m forward P/E (Exhibit 8). This discount has widened slightly in recent weeks as the Conservative Lead in the Polls has narrowed. But the discount is only fractionally larger than the long-term average vs. FTSE All share. At recession points, such as the early 1990s and 2008, the P/E discount for domestic names rose to as much as 20%; today it is 7%.
That said, we do not forecast a recession for the UK, and would not argue for a large de-rating in these stocks. We do think however, that ultimately UK growth will slow, driven by a softening in consumer spending this year, and this is likely to mean weaker earnings for the domestic stocks.
Meanwhile, Deutsche Bank is out with their own “election night preview.” To wit:
Opinion polls have narrowed significantly as the election approaches, from highs of a 20 point Conservative lead over Labour to current poll average of 7pp at the time of writing. While current polling still remains consistent with the Conservatives increasing their current slim majority, the tightening of polls and their wide range has increased the likelihood of alternative election outcomes. Looking towards Thursday’s vote, we analyse the trends and variation in the recent polls and preview the likely timelines for election night itself as well as the potential formation of a coalition government.
Poll narrowing has increased the probability of alternative election scenarios Following the sharp narrowing of the Conservative’s polling lead in recent weeks, the Conservatives’ lead over Labour is now down to 7 points. Comparing this to the historic margins of error seen over previous elections, current polling remains just in excess of the largest polling miss observed since 1992 – a 6.3pp overestimate of the Labour vote share in 2001 – and well in excess of the average polling error over these votes. At the same time, in elections since 1992 the pollsters have consistently underestimated the Conservative’s vote share, by 2.1pp on average. (chart below).
Given this clear trend for polls to underestimate the Conservatives for various reasons, including issues of poor sampling together with the “shy Tory phenomenon” – pollsters attempt to correct their survey results to account for this dynamic. The risk therefore is that the polls could be over-correcting and therefore giving the Tories an advantage in the polls.
As the chart below shows, the raw voting intention data behind the most recent polls from each of the main pollsters is relatively similar, with a limited spread across companies. There is, however, a much larger dispersion of results when looking at the final headline poll lead that is published. Indeed, from an average Conservative lead of 1.3% based on the raw data, the lead increases to 6.3% after the polling agencies’ re-weighting, with a much wider spread.
In other words, the wide range in the headline Conservative lead across polls is a result of the statistical re-weighting employed by the polling agencies in an attempt to correct for previous Conservative polling misses rather than a result of variation in the raw survey data. With the Tory poll lead ranging from +1 to +12 across different polls, the key question for election night will re-weighting will be most correct. The chart above compares the current re-scaling of voting intention by company relative to the miss of that polling company in the 2015 general election. Those companies reweighting the Conservative vote share the most in fact tended to better predict the 2015 final result. Thus, while there is significant re-weighting of polls in favour of the Conservatives, this should not in itself imply the Conservative lead is being over-stated. Indeed, in 2015 the pollsters currently re-weighting the most – ComRes, IpsosMori and ICM – tended to get closest to the final result.
And finally, here’s the schedule: